BiggerPockets

Many have argued/claimed here on BP that cash flow on residential properties is of vital importance and investors can not put food on the table with appreciation. I disagree. Once you have built a business with many rentals, you could sell one or two, or as many as necessary each year grabbing the gains from it to live off. This is not to say that you should not have positive cash flow on residential properties, you should. Only to say that it is not the only income source form the property.

Another claim is that you must buy at huge discounts to turn a profit in residential RE. Although I agree getting a huge discount is advantageous, it is not the ONLY way. Just because you buy a sfr for $30k and it appraises for $50k, does not assure you have 40% equity, nor does it assure you will turn a profit on the sell down the road. In fact, in many cases, the $30k you paid is all it is really worth and the so called equity in that area will vanish. What is important is the demographic studies: Strong diverse economy, strong job grwoth, improvement in infrastructure, strong potential appreciation, reduced vacancy trends, ratio of supply & demand, and an undervalued market.

I have read here that some buy in lower income areas at 60% of the current value in places that show poor demographics where population is decreasing and jobs are leaving. So just because you can buy at 60% of value today and turn positive cash flow, does not assure a profit down the road. Who will rent the unit when the supply beats demand and when there are no jobs.

I understand and believe that becoming wealthy from cash flow on residential properties is most likely not going to happen. True wealth is obtained from the appreciation and many tax benefits from residential RE investing. Although I beleive in cash flow, and always strive for it, the true ultimate goal is to eventually sell the residential property for large gains and defer/avoid taxes as permitted by law.

Commercial property is where wealth and long term residual income lives. When purchasing a commercial property, in essence, you are buying the cash flow. In fact, it is valued based on it's performance and not what the unit down the street sold for (comps) like residential is.

Interesting blog Richard. I would have to agree that different or changing market conditions require differnt strategies to maximize profits.

My point of the last post was that True wealth is created over a long term through appreciation and not cash flow, residentially speaking. I also refered to commercial properties as the reason for cash flow. Most experts will agree that residential properties are purchased for appreciation while commercial for the cash flow. Of course, a combination of the two never hurts either.

Thanks for the blog post. It was informative.

I couldn't agree more!

Many have argued/claimed here on BP that cash flow on residential properties is of vital importance and investors can not put food on the table with appreciation.

Cash flow on residential RENTALS IS OF VITAL IMPORTANCE! In fact, the number one reason any business fails is lack of cash flow. So, unless you have a great big pile of money that you want to get rid of, you must have cash flow if you're to be in business.

No one has ever said that you can not put food on the table with appreciation. Many people made a lot of money with appreciation in the boom of the past few years. Unfortunately, millions have also gone bust when they bought at the peak and now are upside down on properties that will not cash flow as rentals and can't be sold, except at a huge loss.

Betting on appreciation is speculation. It's just that simple. Is that a valid business model? Yes. If you've got a good crystal ball and don't bet wrong, you can make a lot of money on appreciation.

Once you have built a business with many rentals, you could sell one or two, or as many as necessary each year grabbing the gains from it to live off.

This is where your argument falls apart. Unless you are rich, most people can not afford to stay in business with negative cash flow on many rentals. So, the hope of future appreciation is totally meaningless when they can't afford to stay in business.

Just because you buy a sfr for $30k and it appraises for $50k, does not assure you have 40% equity, nor does it assure you will turn a profit on the sell down the road.

I agree that appraisals are meaningless. What matters is market value. If you buy a property for $30k that has a market value of $50K, you have $20K equity - period! Of course that equity could go up, down, or remain the same - EXACTLY LIKE IT COULD DO IN YOUR SPECULATION BUSINESS. Millions of people in the boom areas had big net worths until the real estate bust occurred. Now, their speculation isn't looking so good. And since historically (in a normal boom-bust cycle), it takes inflation adjusted prices 8-10 years to once again reach their pre-bust high, they might be back to where they started in about 2018!!! Unfortunately, since this is an unprecedented bust, it could take substantially longer.

I have read here that some buy in lower income areas at 60% of the current value in places that show poor demographics where population is decreasing and jobs are leaving. So just because you can buy at 60% of value today and turn positive cash flow, does not assure a profit down the road. Who will rent the unit when the supply beats demand and when there are no jobs

.

That's very true and Detroit is a good example of that.

I understand and believe that becoming wealthy from cash flow on residential properties is most likely not going to happen.

Of course you're not going to become " wealthy" from cash flow, but the cash flow is what allows you to keep the property and hold the wealth. If you buy 50 properties with an average equity per property of $20,000, you're a millionaire - WEALTHY. The positive cash flow allows you to keep your wealth and of course pay the bills.

Although I beleive in cash flow, and always strive for it, the true ultimate goal is to eventually sell the residential property for large gains and defer/avoid taxes as permitted by law.

That's YOUR goal because you're not in the rental property business. However, in the rental property business, the goal is certainly not to sell the asset that generates our income. The goal is to use the asset to generate income. The appreciation, paydown of principal with the tenant's rent, and tax benefits are just icing on the cake!

Commercial property is where wealth and long term residual income lives. When purchasing a commercial property, in essence, you are buying the cash flow.

It doesn't make any difference whether it's residential or commercial. If you have positive cash flow and equity from either investment, the result is wealth and long term income. Money is money and where it comes from is totally irrelevant.

Mike

Mike, I agree 1000% on your post regarding cashflow. For me appreciation is just icing on the cake.

I live in San Francisco (high appreciating area) and I know a lot of people who " invested" for appreciation rather than cashflow. They did get " rich" during the boom, but have since gone broke when the market turned. The rents were less than the mortgage, even with interest only/neg am loans, so they all had to put money out for the difference. You can just imagine having several multimillion $ properties with negtive cashflow can do to one's bank account. I don't care how rich you are.

For me it's all about having your money work for you. Most of my investments are outside of CA since I mainly invest in cashflowing properties. Even if none of my properties appreciate, since my tenants pay down my loan through rents (principal included), I still build equity without doing anything else but make sure my properties are occupied. So in the end I still become richer because someone else paid for my loan, increased my net worth and still had money coming in every month. The only money I put out was my down payment. That's why I look at my tenants as my sales team in my business, because they're the ones that pay down my loan and increase my net worth. In short, they bring in the revenue!

Speaking of commercial RE, cash flow definitely matters since a property's value has a lot to do with it's income and expenses. So the higher the income/lower expenses, the higher your property value becomes.

As they say: Equity does not pay the bills....cash flow does. Or was it house rich but cash poor? :)

Cheers everyone!

I expected you to chime in on this one Mike, and as usual, you make assumptions in regards to what and how I run my particular business when you know nothing about it. My post was not to argue that cash flow is not important, simply to point out that cash flow and appreciation can go hand in hand if you build a business model that strives for that.

Betting on appreciation is speculation. It's just that simple. Is that a valid business model? Yes. If you've got a good crystal ball and don't bet wrong, you can make a lot of money on appreciation.

Appreciation is not gambling over long-term and no crystal ball is needed, only the ability to study history. You still can not name one real example of more than a ten year period in which RE did not appreciate. It has time and again, and once we get through this current buyers market, the sellers market will return in the future creating more appreciation.

No one has ever said that you can not put food on the table with appreciation.

To refresh your memory lapse, you did! You said (and I quote) " I can not eat appreciation" .

Many people made a lot of money with appreciation in the boom of the past few years. Unfortunately, millions have also gone bust when they bought at the peak and now are upside down on properties that will not cash flow as rentals and can't be sold, except at a huge loss.

While I agree with this statement, you are talking about greedy or uneducated investors in this example. I know many others who cashed out close to the peak and made and kept millions. Now that the market is depressed, they are back in buying. The key is doing your homework, avoiding what the masses are doing, and and use fundamental analysis to evaluate the market conditions. You do not. You buy and hold low income properties for cash flow. That is fine for you. Not for everyone. I do not believe it benefits me, you or anyone else to attempt to poke holes in my business and strategies. It reflects a more poor image on you than me.

We are all here to learn and we all have differnt ways, goals, and strategies to invest in RE. One of the many reasons why this business is so great. A person with a shy personality would not do well talking to homeowners in foreclosre, so there are many other opportunities for them to make $ in this business. My goal of this post was to discuss differnt points of view and strategies in rleation to cash flow and appreciation. If we can stick to that, rather than make assumptions or attacks on other's business models, more people can learn from the post.

Of course you're not going to become " wealthy" from cash flow, but the cash flow is what allows you to keep the property and hold the wealth.

I agree, which was my point that cash flow and appreciation can go hand in hand. While cash flow is a positive, if an investor was to have $0 cash flow and brake even for 10 years on 10 properties, but cashed out on the appreciation of $50k on each of the 10, the investor would have made much more than just the $100 per door.

I live in San Francisco (high appreciating area) and I know a lot of people who " invested" for appreciation rather than cashflow. They did get " rich" during the boom, but have since gone broke when the market turned. The rents were less than the mortgage, even with interest only/neg am loans, so they all had to put money out for the difference. You can just imagine having several multimillion $ properties with negtive cashflow can do to one's bank account. I don't care how rich you are.

Again this senario is talking about foolish and uneducated investors. Had they done their homework and avoided the urge of greed, they would have cashed out of the market prior to the peak.

Final point is that while cash flow on res. properties is good, and in many cases needed to sustain the property over time, it is not always necessary to have boat loads of $ in reserve but simply enough to cover rainy days which we both know will occur over a sustained holding period.

The reason I'm emphasizing cash flow over appreciation because a lot of new investors read this board. A lot of people have lost their shirt by speculative investments in hopes of becoming rich quick through appreciation. I say focus on cash flowing properties in growth areas. Everything else will follow.

I agree that investing in properties that cash flow make sense and to sustain a negative while holding requires other sources of income or reserves, there is no question. But as you said, " everything else will follow, meaning the appreciation over time will amount to large paydays, and by keeping some as income, and re-investing the balance using tax deferred strategies to avoid tax liability, will put the $ right back to work for you again, only in larger and larger properties/profit makers.

Look at this chart. http://mysite.verizon.net/vodkajim/housingbubble/

If you look at the inflation adjusted housing prices, you'll see that housing prices were actually lower in 1997 than they were in 1979 (adjusted for inflation). Even if you look at ACTUAL prices from 1979 to 1997, you'll see that it took prices 18 YEARS FOR THE PRICES TO DOUBLE! If you would look at a chart of the Dow Jones Industrial Average for the same period, you would see that the Dow went up about 700% in that same time period. So, if you're looking at speculating on appreciation, stocks are almost always better.

The other key thing to take from the chart is the extent of the recent bubble. You can see how abnormally steep the chart was during the boom. What do you think that means for prices on the way down and the length of time it will take for prices to reach their recent high?

I expected you to chime in on this one Mike, and as usual, you make assumptions in regards to what and how I run my particular business when you know nothing about it.

I'm not making assumptions, I looked at your website. Why not set the record straight and tell us what your business is? It certainly looks from your website like you're selling properties to newbie investors at near retail price. Is that incorrect? From what you have said, it looks like this is based on speculation of future appreciation (that's how the newbie is supposed to make money). That would mean that you make your money selling the properties and the newbies make money if the property appreciates in the future? Is that right? It also appears that the properties you're selling have a negative cash flow when real world expense numbers are used. Is that correct?

This below was taken from an article that listed the 10 bigest mistakes investors make. It was #4 on th elist of 10.

Real Estate Investment Mistake 4
Making the Cash Flow Mistake

RIDICULOUS! Which guru wannabe wrote something that stupid?

While I agree with this statement, you are talking about greedy or uneducated investors in this example. I know many others who cashed out close to the peak and made and kept millions.

Who do you know that cashed out at the peak and kept millions? I don't know a single person that did that (although I'm sure there are a few. Moreover, many very educated and seasoned investors lost their butt during the current bust. In fact, all along the line, experienced investors lost tons of money. Look at Bear Stearns. You won't find more experienced and educated investors than Bear Stearns. Yet, they misjudged the real estate landscape and lost nearly everything.

The key is doing your homework, avoiding what the masses are doing, and and use fundamental analysis to evaluate the market conditions. You do not.

Quite the contrary! While the masses were flipping houses in hopes of instant riches through runaway appreciation, I was buying boring little houses and apartment buildings at a huge discount (instant appreciation) that had positive cash flow. My fundamental analysis in the early 2000's revealed that the unprecedented runup in prices could not be sustained and that we were in for a huge real estate bust. My fundamental analysis tells me now that fewer and fewer taxpayers can not pay for all the entitlements in the next few years and that the US economy is going to collapse. When that happens, housing prices will plummet and rental properties will be just about the best thing to be holding. Of course, the value of my rentals will plummet too, but it won't matter because I will still have my silly little cash flow to live on. That's my fundamental analysis.

If we can stick to that, rather than make assumptions or attacks on other's business models, more people can learn from the post.

No one attacked your business model. In fact, I believe that selling properties to newbies is a good way to make money. I also believe that speculation is a valid business model and IF the market starts rapidly appreciating (I don't think that will happen for a long time), appreciation could make many people rich. If I have in any way mischaracterized your business model, I invite you to correct me.

Again this senario is talking about foolish and uneducated investors. Had they done their homework and avoided the urge of greed, they would have cashed out of the market prior to the peak.

That's ridiculous! How were these people supposed to know when the peak would be? Did you know what day that was in advance? Do you know what day the real estate bottom will occur? What does the future hold for real estate? Please be specific. BTW, that's the reason it's called speculation, because it's all guess work!

Mike

I've only been holding rental propeties for about 2 years now, so I consider myself a noob. But, I don't think of it as buying RE, I'm buying an income stream. If I can spend $3000 and buy a home that pays me $100 per month for as long as I own it, do I realy care what someone else thinks its worth. To take my example to another level, if I own a portfolio of properties that pays me $10,000 per month, does it make any real difference if they are worth 200k or 500k. I'm still retired with a great income (my dream only). The only time the value comes into play is if I sell them....but if I sell them I may have 500k in the bank, but I can't live forever on that. I will miss the income stream more. Back to the 9-5 job in that case. Maybe I'm way off, I'm just a noob.

steve

Originally posted by "SROC4"

Originally posted by "nationwidepi"

This below was taken from an article that listed the 10 bigest mistakes investors make. It was #4 on th elist of 10.

Real Estate Investment Mistake 4
Making the Cash Flow Mistake
Cash flow is an important piece of the real estate wealth puzzle. But you can rob yourself of future profits by putting too much emphasis on just this one, albeit important consideration. ....

Not sure who wrote that one, is he/she a reliable source? ...

Judge for yourself:

http://www.convergentacquisitions.com/real-estate-investment-mistake-4.php

Here's their home page:

http://www.convergentacquisitions.com/index.php

and the full list of " mistakes" .

http://www.convergentacquisitions.com/10-real-estate-investing-mistakes.php