A Guide to Cash Flow For a German Property Investment.
A common aim of all of our investors in “a strong yield delivering a positive cash flow”. So when all is said and
done, how much can you expect to be left with at the end of the day, after finance payments and other deductions? This is a question we frequently get asked by our clients and is one that this guide will hopefully help you determine which investments will be truly “cash flow positive”
What Factors Determine Cash Flow?
Well, clearly the are some obvious factors, and perhaps so not so obvious factors which are to be considered:
1. Rental Income, or yield of the property
2. Level of finance taken, ie what percentage of the value
3. Prevailing Interest rates
4. Finance type, repayment or interest only
5. Likely maintenance costs
6. Management fee
7. Income tax
Lets take in each turn and discuss what factors could be modelled
This will be made clear for most investments, or if the property is vacant when purchased a likely rental figure can be obtained from a letting agent or letting portals. The point to make here is, depending on the property and its quality, what length of vacant periods are sensible to factor in and what rental increases can be considered during the length of your hold. This takes some expertise, but as a rule of thumb we say for average locations that perhaps a 3% vacancy period is factored, more if a lower grade part of a city or in a city which has a decreasing population. In terms of rental increases, it is tempting for simplicity to model that “cost of living increases” will apply. This is sensible as a model, unless the property is purchased with low rents compared to the market, or in an area where rents are increasing [or decreasing] more significantly. All things being equal then, a cost of living index can be applied to income, with the understanding that rents rarely follow such a gradual increase and usually increase in a step wise manner periodically.
Level of Finance Taken
It is clearly quite easy to buy cash flow property if you just purchase a property with cash and no finance. This strategy is followed in prime markets such as Munich where yields are so low that only holding with cash will deliver a return. Holding property with an increasing amount of debt will clearly affect cash flow. Purchasing a unit with 80% finance, and still achieving a cash return is a nice outcome, and one sought by many of our investors as it minimises the use of their equity at the start [allowing more purchases to be made perhaps].
There is a real tension here with getting 80% finance, as banks will only give this in the best locations, and these tend to be locations with lower rental yields as the risks are lower. Finding an object that is 80% financed, in a prime spot, and still delivers a monthly result is a very good outcome in any market and is still possible in Germany.
Prevailing Interest Rates
Obviously the lower the rate, the better the cash flow will be. But here comes a choice for an investor. Do you take a shorter term fix product and get a better initial cash flow, or a longer term product and remove the risk of increasing rates at the end of your shorter fix. It is usual than longer term fixes are more expensive, in line with what money markets called the “yield curve”. To give an example of this today, 5 year fixes in Germany are around 2,8% and 10 year fixes at 3,6%. Historically low [May 2012] but it is a real guess as to where they may be in 5 or 10 years time. Choosing the term of fix then will affect the cash flow and also the risk or rate changes depending on the product chosen.
Here we are talking of if the finance taken is on a repayment or interest-only basis. Both affect cash flow of course, but it is unfair to judge both equally as the repayment method will clear your loan at the end of the term, whilst interest only will leave you with the original debt all the way through. Many investors like to take interest-only, as this improves cash flow and the ability to make subsequent purchases out of money generated. But fewer and fewer markets offer such products these days, indeed Germany our home market is all repayment only. It is up to you how to model the effect of just interest or the total repayment, but of course the real cash flow in the pocket will be after the total payment. To help calculate both types, there are many calculators on line such as here:
Likely Maintenance Costs
This one is very hard to model, not knowing what may come up in the period of your hold. Of course you can insure the property to various levels and this will help plan to some extent, but what figure is reasonable to both model for cash flow and set aside for maintenance purposes. Well, of course it will depend on the property condition and any outstanding works that are needed. It is best to factor into year 1 of your cash flow calc any known issues, whether you deal with them then or delay for a while. Beyond this, surveyors will usually assign a value per sqm that should be needed per year if all things are equal. This calculation will not only include day to day maintenance like doorbells, painting staircases and the like, but also big ticket items like boiler replacement and roof. The standard figure we use for our “average” property is 8 Euro per sqm per year. So if you have a 500 sqm building, factor in 4000 Eur per year for works. Of course, for a newly refurbished building, where nothing beyond wear and tear should go wrong, a much lower figure can be used.
Within the German market there are 2 prevalent management models, one that charges a fixed price per unit [rented or not] and another which charges a percentage of the collected rent. The decision between the 2 is the topic of another guide which has been written, but clearly the decision does have an effect to cash flow. To most easy to model is clearly the fixed fee per apartment as there are no variables, but cash flow modelling will not be your driver as to which model you choose of course.
The hardest one to model, and comes down to so many circumstances which an individual has in their tax circumstances. For a quick and dirty cash flow analysis, tax could well be “ignored” knowing that if you make profit then tax is due and you cannot do anything about this. But to understand to true cash return of an investment then your circumstances should be modelled on to the cash flow as best you can so an accurate picture is given.
SO, What Does all Leave Us?
Well, as you can see, there are many deductions to consider and model and in fact if these are truly taken into account then there are few markets in the world, especially when higher levels of finance are taken on a repayment basis, where cash flow each month is a result. Indeed, the purists will also look to their deposit put down and see an opportunity costs of this, and the interest that could have been gained in a deposit account as a deduction to cash flow.
To give an example from a notional 700,000 Euro, 1000 sqm apartment block, with 10 apartments and a rental yield of 8% and in “average” condition, we would get the following :
Purchase Price 700,000 Eur
Rental Income 56,000 Eur
Management Fee [20 Eur per apartment per month assumed] 2.400 Eur
Maintenance [8 Eur per sqm per year] 8.000 Eur
Finance Payment (Capital and Interest Repayment on 80% LTV over 20 years) 36.588 Eur
Cash Flow In Year 1 =9012 Eur
That’s just for year 1. As you model rental increases in, this will tend to rise of course throughout the period of hold.
The good news is that, for most investments in today’s low-interest environment, a property with a yield on purchase price of perhaps 7% or higher will tend to deliver a monthly cash flow, and these are the units which ProVenture market and we list the cash flows on each of our expose to help.
If you have any more questions, please do not hesitate to get in contact with us.
The ProVenture Team.