Why cash flow is king if you have a low-income

If you’re looking to buy an investment property, one of the main factors you need to take into account is just how much cash flow your property is going to produce.

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While cash flow is not everything, if you’re on a lower income, you’re going to need to use that rental income to help you get into that first property and also build your portfolio.

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Here are some reasons why cash flow is king.

Boosts serviceability

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When a lender looks at how much you can borrow, they will take into account your income and expenses. That makes sense as they want to know that you are going to be able to pay the mortgage on the property that you’re buying.

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However, they also take into account the rent that you’re going to be receiving from the property. The more rent you bring in, the more they will lend you.

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If you’re on a low income and things are a little tight, that rental income is going to go a long way to securing a loan. You can’t build wealth in property very easily without finance, so getting a loan is a key part of the equation.

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A property with a rental yield above 5% will go a long way to helping you buy. On the flip side, if you wanted to try and purchase something that is heavily negatively geared with a rental income of 2%, you would need a lot more income to service that loan.

Future rents

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The other great thing about lenders accepting rental income is that they will do it for properties that aren’t even built yet.

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For example, if you want to buy a house and land package somewhere, the lender will also factor in the income that you will get when you rent out the property.

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This can be a clever way to get into the market with a lower income. You’re firstly paying less stamp duty as you are only purchasing the land. But a lender will allow you to factor in future rental income as well.

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Rents rise

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One thing that often gets overlooked but is incredibly powerful is the fact that rents rise over time.

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If you have a property with strong cash flow when you purchase it, your yield actually grows over time.

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For example, if you buy a property for $400,000 and get $400 pw or $20,000 per year in rental income, that gives you a yield of 5%. After a few years, that rental income might jump to $500 pw. Based on what you paid for the property, your effective rental yield has also jumped to 6.25%.

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Over time, your yield will keep rising to the point that you could be bringing in over 10% per annum, based on what you paid for it from rents alone.

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Can hold for longer

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We can see that cash flow is great, but it also ties in with growth. The growth element is what actually helps move your portfolio forward, but that will take time.

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When you have a property that has a strong cash flow that is around neutrally geared (i.e., it’s not costing you money to hold), it means that you can hold onto the property a lot easier.

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In the past few years, we’ve seen many investors forced to sell because they bought when mortgage rates were 2%. Now that they’ve tripled, those investment properties are a lot less appealing to hold onto and they are forced to sell.

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If you can’t hold onto the property, it’s tough to build a portfolio. Higher cash flow will give you that buffer and buy the time that you need for the capital growth to kick in.

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