Case Study: Why Investing In Commercial Property Generates More Cash Flow

When it comes to property investing, cash flow is king. Cash flow is the money left over after collecting rent and paying expenses like mortgage, insurance, taxes, and repairs. Positive cash flow means your rental property generates a monthly profit, while negative cash flow means you're losing money.

While some investors chase future capital gains by accepting negative cash flow, most savvy investors prefer properties with positive cash flow from day one. Commercial properties are particularly renowned for their strong cash flow potential, making them a prime target for investors seeking steady income streams.

Crunching the Numbers on a Regional Dental Clinic

Let's dive into a real-world example to understand cash flow calculation better. Imagine you've acquired a regional dental clinic as an investment property with an existing tenant:

Details:  

Return on Investment (ROI): The Ultimate Measure of Success

Return on Investment (ROI) evaluates an investment's efficiency by comparing its returns to its costs. For our dental clinic example, let’s compare the ROI with the dental clinic when we have rental increases, which should equate to capital growth with an unchanged cap rate:

In the first year of owning the dental clinic, the return on investment (ROI) was 10.38% pre-tax. This figure represents the total pre-tax cash income of $31,500 for that year, divided by the acquisition costs of $303,600. As evident from the 'Equity' row in the table, there was no capital growth during the initial year, so it was not factored into the ROI calculation.

However, over the subsequent five-year period, with rental increases of 3% annually and a corresponding 3% capital growth rate, the combination of accumulated cash flow and the available equity propelled the dental clinic's ROI to impressive heights. 

By the end of the fifth year, the pre-tax ROI had soared to an exceptional 95.5%. The potential for even higher returns further amplifies this remarkable outcome if interest rates and cap rates were to decrease.

Leveraging Your Investment: The Impact of Interest Rates and Loan-to-Value Ratios

The table illustrates how ROI fluctuates with varying interest rates and loan-to-value ratios (LVRs). Your LVR depends on factors like down payment size, all-cash purchases, or leveraging equity from another property. It's possible to obtain a 100% LVR by using equity from an existing property to finance the entire purchase.

At lower interest rates, higher leverage maximises cash flow ROI. However, being highly leveraged carries risks - high-interest rates can make the ROI negative. If the property becomes vacant, the owner faces significant cash flow stress.

With a 100% LVR using another property's equity as the deposit, a market downturn could put the owner in negative equity, requiring additional funds to pay off the mortgage upon sale. Carefully consider your personal circumstances and risk tolerance when determining the appropriate LVR.

For an in-depth discussion on LVRs, refer to my book "Residential Property Investing Explained Simply."

The Path to Debt Freedom: Paying Down the Principal Loan

As the table shows, when paying down the property's mortgage, the yearly cash flow increases as interest repayments reduce annually.

In the eleventh year, the property becomes debt-free, resulting in an unencumbered (debt-free) yearly cash flow exceeding $92,000 the following year. Additionally, the investor would have achieved significant capital growth.

Key Takeaways

While real estate investing offers various avenues, commercial property investing stands out with distinct advantages. As demonstrated in the case study, commercial properties can yield significantly higher returns on investment compared to residential properties.

Moreover, commercial properties tend to exhibit less volatility than their residential counterparts, translating into a more stable and consistent income stream for investors.

I hope this has provided valuable insights into the merits of incorporating commercial properties into your investment portfolio. However, if you're interested in learning more about how I've guided thousands of investors towards successfully acquiring commercial properties, don't hesitate to reach out today.