YOU HAVE PROBABLY SEEN a number of other software packages out there on the market, which will encourage you to create 7 to 10-year projected cash flows.
In most cases, they have been designed by Techos and NOT by investors. And as a result, they lull you into a false sense of security. Fundamentally, there are two main reasons why I consider them to be laying a trap for even seasoned investors.
I don’t know about you … but I threw my crystal ball away several years ago. And realistically, I can only be reasonably confident in projecting forward for about the next 3 to 4 years.
To make projections any further than that, you will need to adopt arbitrary inflation figures to increase your expenses; and try to estimate at 7 to 10 years into the future, as to what the market rentals might be. And as such, those projections will end up bearing a little resemblance to what actually takes place.
However, my main reason for limiting your projections to no more than 4 years out is because that’s when your greatest expenses occur.
When you Buy the Property
These involve things like stamp duty, your various acquisition cost like legals, valuation etc – and can add up to as much as 8% of the purchase price – bearing in mind that stamp duty alone is 5.5% of the purchase price.
Your next major timing for expenses is …
When you Sell the Property
That includes things like your selling commission, advertising, legals and so on.
As such, by spreading those significant costs over 7 to 10 years, that merely serves to artificially inflate (and therefore, distort) the overall return you are likely to receive from your property.
Adopt a very simple Rule of Thumb
I would suggest you should strive to achieve an after-tax return of at least 10% pa, over a 4-year period.
Because that way, the calculation will provide you with a built-in safeguard of knowing you’re still making money even if (for whatever reason) you find yourself having to sell the property somewhat earlier than you had originally planned.
Even so, there are people who seem dissatisfied with merely a 10% return on their equity. However, you need to remember this is an after-tax return.
And therefore, your equivalent pre-tax return will depend upon your tax rate.
Bottom Line: If the ultimate beneficiary of the income is a company at a 30% tax rate – your pre-tax return is actually 14.3% per annum, on the equity you invest in the property.
And if you are an individual on the top rate of 45% … the annual pre-tax return would be 18.2% per annum. And I wouldn’t have thought these sort of figures were too shabby … particularly, in the current investment climate.