13 May 2014

Positive cash flow without putting any cash at risk! Too good to be true?

Saw an online video clip on YouTube recently by this lady who was selling her concept of developing wealth. She was schooled in the art of "Rich Dad, Poor Dad".  I've no grouse with the general idea of "positive cash flow" though I guess some of the concepts may run contrary to accounting practices in the way assets and liabilities are normally tagged.

She gave an example of a Singapore property and asked the audience if they would invest in it.  Essentially it had a negative cash flow due to the high loan payments compared to the rental income.  The obvious answer was no.  But she postulated, what if she had a way to turn this into positive cash flow?  I was intrigued to say the least.

The concept?

Idea #1.  Secure an interest-only loan payment.  The argument being that since this is for the purpose of generating income from rental and not for capital appreciation, taking this approach helps to reduce the loan payment and hence shifts the cash flow equation to the positive.  Not bad.

Idea #2.  Obtain a capital refinancing.  She made it clear to differentiate between refinancing a loan (which I understood) versus capital refinancing (which I had no clue about).  It sort of work like this.  Suppose you could obtain a loan of 80% against a $1,000,000 property - i.e. $800,000.  So you had to put down $200,000 as the upfront down-payment. 5 years later, the value of the property has appreciated to $1,200,000.  Recall Idea #1?  So, the loan principal has remained at $1,000,000.  But since the value of the property has now appreciated to $1,200,000, the capital refinancing would offer a revised loan at 80% giving $1,000,000.  You would therefore have extracted the $200,000 you had put down earlier!  Of course, the loan repayment would have increased.  But she argued that the rental income would likely have similarly increased as well.  Amazing isn't it?  Over 5 years, you have effectively put no cash into the investment and would still generate a positive cash flow from the rental income!  I also want!

What's the catch?

Catch #1.  Notice how the assumption in Idea #2 contradicted Idea #1.  She said we should not invest for capital appreciation but to achieve positive cash flow.  But what was the assumption in Idea #2?  Capital appreciation!

Catch #2.  What happens if the value of the property drop?  The bank is going to come calling for a cash top up!  Do you have the cash reserves to respond when that happens?  Are you still cash flow positive? Companies can die when they don't manage their cash flow properly from month to month.  For the individual, it could mean bankruptcy and a miserable rest-of-the-life.

Catch #3.  Does the economy remain healthy always and you can be assured of the rental income?  More often than not, when things are getting bad, it just gets worse. The very scenario in Catch #2 is also likely to be accompanied by a poor economy. What happens?  Your rental would also go up in smoke.  Now the ability to service the loan has just been compounded by an amount equal to the lost rental income!  Double whammy!

Speaking of which, got a call from a friend (person A) recently, asking for the number of another guy I know (person B).  A was trying to get in touch with B over his investment.  Seems A had invested in some gold-related scheme with B.  I happened to know B had been scammed by his business partner (absconded!) and was desperately trying to get his life back.  B was now driving a taxi to make ends meet.  I guess friend A has to kiss his investment goodbye.  Sad.

No comments: