The opportunity to take profits on your real estate investments is one which should be considered in great detail but profits are not necessarily the be all and end all of real estate investment. The ability to buy and sell assets and bank a significant return can take many months or even years to complete and financing your liabilities in the meantime is vital. This is where cash flow comes into play to ensure that, as much as possible, your investments are self-financing and able to cover the liabilities you take on.
Financial liabilities
You may come across an array of “short-term” opportunities but very often these opportunities can drag on for some time adding additional expense to your finances. If you gambled everything on a short-term opportunity creating a large profit, without any cash flow to cover the financial liabilities, what happens if the sale of the underlying assets was delayed or cancelled?
It is imperative that you give yourself some “financial headroom” when looking at the real estate market and in a perfect world you should have a backbone of long-term assets which create long-term income streams in the form of rent. The idea is that the value of these properties would gradually increase in the longer term and the cash flow would cover all of your financial liabilities and hopefully leave some “headroom” in the event of unforeseen costs.
Tight timescales are dangerous
Anyone who has bought and sold property around the world will be well aware that what are seen as relatively simple transactions can sometimes drag on for months. Buyers come and buyers go and nothing is ever certain until the money is in your bank and ownership has been transferred. The real estate world is littered with investors who were promised short-term returns only to see timescales extended, often finding they were unable to fulfil their short to medium-term financial obligations in the form of loans and loan interest. So what happens next?
You would not need to look far to find examples of asset fire sales because investors were running short of cash and in some cases their loans had been called in by the banks. In this situation the assets will be sold as quickly as possible and very often below the theoretical market price. The fact is that when time is against you, the banks are on your back and you need to find money as quickly as possible, then beggars can’t be choosers and many investors have been forced to accept submarket offers.
Speculation is good in moderation
The idea of speculating on the real estate market and indeed sometimes using debt to give leverage is risky but it is perfectly acceptable in moderation. You will obviously need to do your research, have backup plans in mind and ensure that your financial liabilities are at least covered. In a perfect world long-term rental income would cover all of your financial liabilities while well researched speculative investment and a backbone of gradual capital appreciation would give you the perfect foundation. However, nothing is ever perfect!
Whatever mix of speculative and long-term property investment you decide to go with it is imperative that you have the financial means to cover your short, medium and long-term financial liabilities. You may have the best assets in the world, you may have a large theoretical profit but if your cash flow does not cover your financial liabilities then you may be forced to sell at least part of your portfolio as quickly as possible. Quick sales very rarely result in the best price for the seller!