15 Jun Why high cash flow can be a false idol
With the staggering number of investors in pursuit of properties with great cash flow it seems almost unthinkable – high cash flow can sometimes hurt you. Here’s four issues many investors never even consider.
Properties with high cash flow are what many investors are after – and it makes sense. The better your cash flow, the easier it is to make loan repayments and persuade the banks to extend you further mortgages.
While there’s no disputing the many advantages that cash flow grants investors, blindly pursuing only cash flow has drawbacks. In fact, there are a number of acute disadvantages to having high cash flow.
- Because you are generating an income from the positive cash flow, you pay tax along the way. You get taxed on this extra income and money in the tax man’s pocket is going to make it hard for you to create serious wealth.
- Because these properties are usually in regional or outer areas, they can be quite sensitive to economic cycles. Therefore, compared to properties located closer to the centre of major cities, these properties will generate lower capital growth over the longer term.
- There are also potential higher costs associated with maintenance and more tenancy problems due to socio-economic factors.
- From a finance perspective, it can sometimes be harder to get higher LVR loans for some regional properties due to postcode restrictions imposed by lenders, mostly due to their smaller populations. The result is lower leverage which will reduce your return.
Property investors who are into cash flow properties may have one or many of the following reasons:
- They want to use the cash flow generated from these properties to balance the lack of cash flow from growth type properties;
- They feel more comfortable with the property prices of cash flow properties, many believe most growth type properties are overvalued.
- They don’t trust capital gain tomorrow, it may not be there in the future, at least you can count on the cash flow today.
- They are unwilling or unable to use finance resources to cover negative cash flow for a few years until their investment property turns cash flow positive;
- They want to enjoy the journey of property investing by seeing money coming in every month instead of waiting for a big payout one day.
- They believe income is the final determinant of capital gain. Without rental yield, there is no substance to the property value, so investing for yield is safer than growth.
- Some speculate that high enough yield can generate good demand for cash flow properties, hence higher property values.
Whether these reasons are correct or not is not important, what matters is whether you think its right for you. There is no one best way to invest.
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