01 Mar Myths: Cash flow is the most important thing – Michael Yardney
Regular guest Michael Yardney shoots holes in the theory that property investing is all about cash flow. He says rather we should be looking at it as a high growth low yield investment strategy. He explains more today.
Kevin: As we continue to dispel some of our myths, I’m going to catch up with Michael Yardney right now.
Michael: Hi, Kevin.
Kevin: Michael, I wanted to talk to you about another myth that I’ve heard, and that is that cash flow is the most important thing when it comes to investing. What would be your reaction to that?
Michael: Kevin, the crux of my successful property investment strategy is that residential real estate is actually a high growth but relatively low yield investment. Residential real estate doesn’t give a lot of cash flow.
There are four ways you can make money through property, and I think most investors get it wrong how they do it.
Kevin: Could you tell us how they’re getting it wrong?
Michael: The first way is capital growth. Your property appreciates in value over time. The second way you make money out of a property is the rental return. That’s the cash flow that you’re asking me about. The third way is accelerated or forced growth. This is where you manufacture some capital growth through doing renovations or doing a development. The fourth way is tax benefits, things like negative gearing or depreciation.
Out of all of these, in my mind, capital growth is the most important. I know not everyone agrees with my strategy. In fact, when it comes to property investment, you’ll hear the two conflicting stories bandied around.
Kevin: We’ve talked about your five-stranded approach and we’ve featured it in the show before, but let’s go back over a couple of those points that you’ve mentioned there, Michael.
Michael: The reason behind it is because I believe that the first stage of building property investment wealth is by building your asset base. There is no doubt that you have to watch your cash flow. The reason most people don’t become financially independent is because they spend more than they earn, so you have to get cash flow management right.
But having said that, residential real estate doesn’t give you cash flow. I see people who come to me and say, “Michael, I’d like to buy a property investment and I want it to pay my school fees,” “Michael, I’d like to buy some real estate and it’ll pay for my holiday.” It doesn’t work that way. You have to let it grow.
That’s why the five-stranded approach is to find properties that outperform the averages with regard to capital growth. Once you have an asset base, Kevin, then you lower your loan-to-value ratios and then you turn it into cash flow.
Kevin: Michael, are there any times when you actually would look for a cash flow positive property?
Michael: Sure, Kevin. Once you build a substantial asset base and you transition to being into the cash flow stage where you’re starting to live off your properties, then often I’ve had commercial real estate but not residential real estate looking for positive cash flow.
The problem is you can never turn a cash flow positive property into a high growth property because of its geographic location, because of where it is. But you can actually achieve both high returns – cash flow – as well as capital growth by buying a high growth property and then adding value, doing some renovations, doing something that increases its cash flow. This will bring you high rent, extra depreciation, and that converts your high growth, relatively low cash flow property into a strong cash flow positive property.
Kevin: That is part of your strategy – isn’t it? – to look for those sorts of properties where you can add some value and get some extra income.
Michael: Definitely because I don’t want to downplay the importance of cash flow. That’s what gets investors stuck, when there are those periods like we get every cycle where there is no capital growth for a while or, in fact, property values drop a little bit or during those high interest rate periods. So you have to manage your cash flow, but you do that by budgeting and by having a financial buffer, having something set aside in a line of credit or an offset account to see you through those lean times.
But if you buy a property that gives you more rent return, higher cash flow, in general, you have to forego either security because you bought a property that maybe isn’t as secure because of its location or you’re going to forego capital growth. In property investment, there are three things – there is cash flow, there is growth, and there is security. You can’t have all three.
Kevin: It’s interesting listening to you, Michael, and reflecting back on a lot of the myths that we’ve been dispelling, a lot of them come about because people don’t have a strategy or they don’t have a plan. Here we’ve looked at one in isolation – that’s cash flow – and you’ve demonstrated to us that that’s not right because it’s not part of the overall strategy.
Michael: Correct, Kevin. Or they have a flawed strategy. When you look at the statistics, we know that less than 8% of investors buy more than three properties. In other words, 92% actually never get past their second property. That never gets them the wealth that they require. In fact, 50% of people who get into property sell up in the first five years. Most property investors fail because they have the wrong strategy, a flawed strategy.
Kevin: I know that you have a series of seminars coming up shortly. No doubt, this will be part of that discussion process.
Michael: I’ve been investing for over 40 years, which means I’ve lived through the difficult times we’re going through, now at the beginning of 2016, so we’re going to be discussing how investors can avoid the minefields, follow somebody who knows where to walk and not tread on the minefields to see them through the next couple of difficult years. I’m getting some experts to join me at those seminars around Australia.
Kevin: Both of them are regular guests on our show. That is Ken Raiss and Dr. Andrew Wilson.
Michael: That’s correct.
Kevin: One of the reasons people should be coming along to your seminar is that things have definitely changed. 2016 is going to bring with it a whole lot of new challenges we’ve never even seen before.
Michael: Every year is a little bit different, but this mirrors the beginning of 2008 when a lot of people were concerned about what became the Global Financial Crisis when issues on the other side of the world affected us. The same is happening again. Much the same happened in 2003. I remember the early ’90s and I remember the middle ’80s when it happened.
Therefore, I am going to use the experience of having invested – and some would suggest reasonably successfully – through those cycles to share the lessons I’ve learned. Boy, did I learn the hard way. I wish I knew what I know now then, but in fact, so have all the other main speakers.
There is nothing to sell at these seminars. We have no properties to sell, so we can actually tell it as it is. There are some difficult times, some bad news, but there is also some good news in there as well because at these times, there are always opportunities, Kevin.
Kevin: Yes, opportunities that others will miss. Are these emerging markets or are they existing markets that maybe have been overlooked?
Michael: No, I think we have to been even more careful with correct property selection because certain markets are going to suffer more during those times, and so I’d be cautious of those.
I guess it goes back to something we discussed only a couple of minutes ago about not waiting for capital growth to occur but maybe manufacturing your own capital growth and most importantly in these more challenging times, protecting your assets by having the right finance, having the right assets, having the right structures because if history repeats itself – and it most likely will – there will be some casualties along the way, Kevin.
Kevin: Since we’re talking about cash flow, what are the other considerations that property investors have to bear in mind to be successful?
Michael: I believe there are a number of building blocks of wealth. The first is to start off with a successful mindset. It’s a bit like if somebody suddenly wins the lottery and if they’ve not got the right head space, they end up losing it. We hear that all the time.
You have to learn the right skills and knowledge from people who have lived through these more difficult times. Then you have to set yourself a strategy. Understand what your strategy is. You also have to get risk management under control in these more challenging times – you always should, anyway – which is owning properties in the right structures, having the right finance, owning the rights to the properties.
We’ve already talked about cash flow. That is important, but the main aim for property investors is to build their asset base, build their equity, because this is capitalistic society we live in. We’re building our capital. It’s not a cash flow-istic society.
Kevin: I want to mention about Michael’s seminar that is coming up in March and April. It’s going to be in Sydney, Brisbane, Adelaide, Melbourne, and Perth. All the dates and all of the details at PropertyMarketUpdate.com.au.
Michael, thanks for your time.
Michael: My pleasure, Kevin.