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Not so long ago, it was possible to buy property in the UK with little or no deposit and still have positive cash flow. I have done this myself on several occasions - in some cases even getting several thousand cash back as well, writes Frazer Fearnhead.

 

However, given the rise in property prices and the hikes in interest rates, it is becoming progressively harder to do.

 

So where does that leave investors?

 

One of the key fundamentals of property investment is to always have positive cash flow. If you are "feeding the alligator" (i.e. when your rental income does not cover your mortgage payments and other expenses) there are only so many properties you can buy before you run out of money and into trouble.

How long exactly that will be depends upon your cash reserves and other disposable income.

Cash flow in the property business, as with any other business, is vital. This is simple, common sense. So why do so many investors buy properties when they know the rental income will not be sufficient to pay the mortgage payments?

They do so because they believe the returns from capital growth will outstrip the amount they are subsidising the property. They also take the view that if they are not putting any money into the deal then it is saving them the traditional 15%-20% upfront deposit. They assume that they can use that sum in other ways; either to subsidise the property directly, or invest it in another vehicle that provides cash flow to compensate for the subsidy.

These investors may also consider that rents will rise sufficiently over the next few years and that the investment property will "wash its face" and be in a positive cash flow position.

The key, as always, is to do your research and your sums carefully.

For Example:  A property is valued at £100,000. You buy it at a discount for £85,000 and use either some form of bridging loan, or a vendor deposit, so that you don't invest any of your own money. But think! Because of the high gearing you are actually subsidising the rent.

You calculate that it will take 5 years before the rent increases sufficiently to put you in a positive cash flow position. (As a rule, rents increase at 5% a year on average). 

Until that break even point, you will need to subsidise the rent/ other expenses for the next 5 years for an average £50 a month. (ie a total of £3000.)

If the property has appreciated by 5% a year over that 5 year period, you will have made a capital gain of £27,629 plus any discount offered to you at point of sale. (In this case, the £15,000 discount secured when buying the apartment.) In this illustration, that could amount to a gain of  £42,629: 14 times the money you have put in to subsidise the property - a fairly good return by most standards.

So, Risk can be rewarding. Risk is not something everyone will feel comfortable with, but it is a means that enables you to build a portfolio with little capital investment. A Risk strategy can work advantageously in a rising market, IF you are careful not to overstretch yourself!

Unfortunately, if you are trying to build a UK portfolio quickly by using gearing, you will be well aware of this strategy. Clearly if you have to put in a large deposit and you are still in negative cash flow, then it's an investment to avoid.

When doing your calculations, you should bear in mind the following points:
  • How confident are you that the capital values will increase? (Prices have doubled on average every 8 years and we believe they will follow a similar pattern in future - but nobody can be certain.)
  • How strong is the rental market? Subsidising mortgage repayments by £50-£100 a month when you are receiving rental income is one thing.  If you cannot rent the property at all the situation becomes much more serious.
  • How strong is the resale market ? Can you genuinely achieve a real, not just a paper, profit? Be especially aware of this in areas where there is a large amount of new developments. Investors in areas like Bulgaria, Eastern European cities and Dubai have proved particularly susceptible to developers' claims of capital growth - but you need to be sure someone will actually pay the asking price and enable you to realise your profit.   
  • Ask yourself: are genuine owner-occupiers buying into the scheme, or is the unit valuation based on a developer's inflated prices? (Remember, that each subsequent development phase will be artifically inflated to exemplify a "quick capital appreciation" for potential investors eager to jump on the gravy train!)
  • Can you balance a negative cash flow property (bought because of the high growth potential) with others that do produce positive cash flow so that overall you are making money and can cope with the subsidy?
  • How much disposable income do you have available to provide for your retirement. I still think subsidising a property purchase despite my comments above can make better sense than putting your money into a pension fund.
  • Do a cost sensitivity analysis - see if you could still afford to subsidise if interest rates went up by e.g. 1%. Take preventative action if this could be an issue by selecting a fixed rate mortgage.

 

Frazer Fearnhead is the Managing Director at The Armchair Property Investor.