Your cash flow projection helps you to estimate how well your investment property’s going to perform. Find out how to create yours here.
Every investor I work with has the same question:
How do I find an affordable and high-performing property?
I’m not going to claim you’ll get all of the answers here. Finding the right investment requires a lot of research and work that I won’t cover in this article.
What I will cover is one of the most important aspects of investing – the cash flow projection.
What is a Cash Flow Projection?
A cash flow projection is essentially an estimate of how much income you’ll earn from an investment property.
You use your anticipated expenses and income to figure out if the property will make money over a set period.
Usually, you’ll create this project for the next 12 months. However, it’s possible to go a little longer with property.
Why Do I Need a Cash Flow Projection?
Think about it like this.
When you invest in a property, you’re basically creating a small business. That property generates an income and requires some expenditure on your part.
You want to feel as certain as possible that you’ll get a good outcome from this new business venture.
That’s why you need a cash flow projection.
Of course, it’s important to point out that a projection is just an estimate. You’ll use data from the past and present, as well as market predictions for the future.
But it’s not a definitive statement of how much you’ll earn from your property. It’s an informed estimate based on the available data.
Your projections can show you if a property’s worth further investigation. I always recommend looking for positive cash flow from it.
Your cash flow projection is also useful when you’re looking for financing.
It could help to convince a wary lender that you know what you’re doing. It almost acts in the same way as a business plan if you’re applying for a business loan. The projection shows you’ve considered all of the issues and have come to the conclusion that you’ll achieve positive cash flow.
That isn’t to say a good projection guarantees that you’ll get a loan. It’s just one of several things that a lender may look for when considering an investment loan application.
Tips for Creating Your Cash Flow Projection
Now that you know the “what” and the “why”, it’s time to take a look at the how.
Following these tips will help you to create a more accurate cash flow projection.
Tip #1 – Take a Conservative Approach
One of your goals with your projection is to mitigate risk as much as possible. If you’re using the most optimistic figures that you can find, you’re opening yourself up to more risk. Your projection only shows what happens in the best case, which leaves you unprepared if things don’t work out.
A conservative approach tends to be safest, and smartest.
A great example of this is allowing for vacancies in your property. Assuming your property is going to be occupied 52 weeks of the year will place your Cash Flow Projection on the optimistic side and potentially resulting in an unrealistic forecast.
Another way to reduce your risk is by actively testing the market to confirm your predictions, this is my biggest recommendation to property investors. To often we give little thought to where our research comes from and is it a trustworthy source. By testing the market, you can confirm your predictions are correct or completely unrealistic.
A conservative projection shows that you’ve taken as many risks into account as possible. Consider every expense and don’t assume that your property’s guaranteed to attract the best rent possible.
If the projections still look good after this approach, you likely have a great opportunity in front of you.
Tip #2 – Understand the Different Methods of Projecting Cash Flow
The basic rule for a cash flow projection is to stack up income against expenses to see if you’ll make money.
The sum goes like this:
Projected Income – Projected Expenses = Cash Flow
Obviously, you want that to be a positive figure. Anything that offers up a negative is not an opportunity that you want to take.
However, a property or room that only offers a 1% or 2% return may not be a great opportunity either. Ideally, you want to see at least an 8% return after taking all of these expenses into account.
Tip #3 – Account for Every Possible Expense
I touched on this in the previous section but it’s worth expanding on here.
You want to incorporate every expense that you can think of into your cash flow projection. There are the obvious ones, such as your mortgage and the expenses attached to it. Stamp duty and tax may also be issues.
Some of these only affect your projections once, whereas others are ongoing expenses.
You have the costs of marketing and maintaining the property to consider. You may also need to build in a buffer to account for vacancy periods.
If you’re investing in an apartment room, you may also have to think about strata fees.
Create Your Cash Flow Projection
I don’t advise going into any investment situation without a cash flow projection. You need it to give you a good idea of how well your property will perform. Without it, you could end up buying something that doesn’t suit your needs.
And at worst, you could lose a lot of money.
Follow the tips I’ve shared here and try to make your projection as detailed as possible.
And always remember that I’m here to help if you need any advice.
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