Let it out at a rent that covers all costs
This isn’t necessarily as easy as it sounds, because yields and capital growth often work against each other.
It is generally true that the higher the yield, the less expectation there is in the market of capital growth. Conversely, the higher the likelihood of capital growth, the lower the yield.
You can try and guarantee a positive cash flow by purchasing high yielding properties, but inevitably you will be reducing the chances of benefiting from substantial capital growth. Obviously this negates the whole point of the plan.
You will need to find the right balance between the yield and anticipated capital growth by researching the sales market and the rental market in your chosen location.
Don’t forget the unwritten rule that properties will always cost more to run than you think. Always make allowance for void periods (when the property is vacant between tenants), repairs, insurance, management fees, gas safety certificates, and 101 things you won’t be expecting. And you’d better try to leave some slack for increases in interest rates.
Not achieving a positive cash flow, or a break-even position at worse, could make the plan seem unattractive. However, it’s worth bearing in mind that in many countries, the USA and Australia included, investors often opt for “negative gearing”. This is where the investor has put money in from other income sources to supplement the cash flow from the property. If capital values are growing quickly enough, or if the property was bought at a significant discount to market value, this additional payment will be worthwhile, and can thought of like a ‘savings scheme’.
An alternative solution put forward by Allen is to set aside part of the tax-free lump sum, when you take, to cover any short-fall on the mortgage payments.
All costs must be covered, but the mortgage must be a priority – the plan won’t work if your property is repossessed. There’s a lot of debate amongst the ‘guru’s’ whether you should opt for ‘repayment’ or ‘interest only’ mortgages. In this case I think the position is quite clear. If you are going to refinance every five years to take the equity out there’s not much point paying the mortgage down. You’d be better off having an interest only loan, which will be cheaper, and which will help you to increase positive cash flow.
Here’s to successful property investing.
Peter Jones B.Sc FRICS
Chartered Surveyor, Author & Property Investor