CASH FLOW: Why you have been analyzing your deals all wrong.

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

This might be my most controversial post ever…that is, until you see what I have to say.

And what I’m talking about is cash flow – and you’ve been lied to about it. Ok, maybe not LIED about it. But it has been GROSSLY exaggerated. I’ve seen the same articles you have. The same books. The same videos. “Just sit back and relax! Collect mailbox money!” That might be possible for someone with significant means but for the average real estate investor this isn’t realistic. Especially in this environment. Real estate is difficult, it is not a “get-rich-quick-scheme” but if you do participate in it then real estate will be one of the best investments you can make. As long as you have the right expectations.

Cash flow is NOT the most important piece of the equation. And I’m going to show you why. First, some historical perspective.

If you have been investing in the past 10 years the current environment is VERY foreign to you. But for those of us been doing this for a while, we’ve seen it before. And if you are “newer” then get used to this. This occurs every 8-12 years. If you learn from this one, you’ll be better prepared for the next one. This is where we make our money. Pre-Housing Crises (pre-2008) interest rates for investment properties were 6.5%-7%. Cashflow wasn’t even part of the discussion. Frankly, neither was the interest rate! Pre-9/11 rates were 7%-8% for investment properties. Everyone knew the score. If you wanted to be a full time investor then you flipped properties. That’s what you did. But if you kept a couple of properties a year, then in the long run you would be very wealthy. Only in the past few years has “cash flow” even been a strategy. But now that prices are so high, interest rates are high, insurance premiums have shot through the roof, etc. many investors are wondering how to make this work. I’ve had people tell me “I’m only buying a property if I cash flow $500 per month”. Ok….I guess I’ll see you in about 5 years? Meanwhile, the rest of us are becoming millionaires while you wait on the sidelines. And at no fault of their own – cashflow is what they were SOLD on.

Here's what I want you to understand about “buy and hold” residential real estate:

Let’s use a single family home with a property value of $300,000
Let’s use an initial loan amount of $240,000
Let’s use an interest rate of 7.25%
And I’m going to give you $150 of cash flow per month
Use a 5% appreciation amount for your property

Let’s see what happens after 5 years:

After 5 years…

$150 of cash flow per month = $9,000
Your mortgage has been paid down to $227,000 = $13,000
Your property is now worth $382,000 = $82,000

So that’s $9,000 of cash flow, $13,000 of principle buy down, and $82,000 of appreciation. We make money in 3 ways with “buy and hold” properties…and cash flow is the smallest piece!

Will you cash flow in this environment currently? No, you will not. At least, I want that to be your expectation. Make your offer a little lower because of it. Also, don’t forget you will increase your rents in year 2, year 3, year 4, etc. So you WILL cashflow eventually but go into the property expecting not to cashflow now. And then you are still going to make $95,000 on a property. Remember Brandon Turner’s article on “How to Make $100,000 per year” – you can read it HERE. Don't forget about it.

If you analyze properties on their "Year 1 Cash Flow" then you are going to miss the boat. Buyer's have all the power now. It's not your fault someone is asking too much for their property! Just adjust your numbers on your offer to account for the difference. Don't miss out on the opportunity that's in front of you.

Thanks for reading!

Cash flow is very important. It's just as important as everything else. To reduce its importance is to not truly understand what each aspect of REI is, and what the role if each income/profit is to a property.
First, if you are a property collector, then everything you say is true. If you are an investor, then negative CF adds to the cost of your property. The role of CF comes in two stages:
1 - To recover your cost,..all of your cost, as fast as you can. Once this happens, you are working with a free property. Paying down your mortgage ISN'T recovering your cost, since your mortgage isn't your cost. True, it is the cost of the property, but it is bein paid for by the tenant (positive cash flow). Your cost, as the REI, is ONLY the cash that comes out of your pocket. So, if you have negative CF, or you use your own money to pay down your principle (buying equity), these just add to your cost.
2 - As your equity builds, you gain nothing,...until you convert it to cash. Once you convert it, and move it forward, it increases in value because of the buying power of this cash. As your property values, and added cash flow from the added properties, grow, you will get to the point where the cumulated CF from the growing number of properties is enough to live off of. Now, the CF's role is income.
Yes, the CF may be the smallest profit number, but it is one of the most important parts to the equation because it allows each property to become self sustaining, and the growth of the equity (cashed in), allows you to duplicate the process,...over and over again.
The CF is VERY important. It's what fuels the system.

1 Reply

Atul Mohlajee

Oak Park, IL · Member since 2014 · 285 posts · 114 votes

3y

I invested $2800000 on rental real estate between 2003 and 2021 mostly between 2011 and 2016, out of which I have paid off $1300000. Current value of real estate is $5000000, and cash flow is $10000 per month plus very conservative estimate as it may be around $120000 even. It is personal preference that I started paying off because since 2018,cash flow has been very hard to find, so I did not want to expand anymore. Currently I am in the process of paying remaining $1500000 that might take years. I also have W2s income to help with payments. I stopped expanding when cash flows dried out because cash flow reduces risk and this was a side gig for me always.

2 Reply

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

3y

Quote from @Atul Mohlajee:

I invested $2800000 on rental real estate between 2003 and 2021 mostly between 2011 and 2016, out of which I have paid off $1300000. Current value of real estate is $5000000, and cash flow is $10000 per month plus very conservative estimate as it may be around $120000 even. It is personal preference that I started paying off because since 2018,cash flow has been very hard to find, so I did not want to expand anymore. Currently I am in the process of paying remaining $1500000 that might take years. I also have W2s income to help with payments. I stopped expanding when cash flows dried out because cash flow reduces risk and this was a side gig for me always.

So you're saying it was better to use your cash to spend on the paydown of mortgages to the tune of $1.3M, in order to $12k CF per year? WOW. That means it would take you 11 years before you recovered the cash you already had in hand,...before you spent it on equity.
Your current PV is $5M. If you used that $1.3M as DP's (20%), that would buy you $6.5M in PV, with the same equity,...but much higher CF.
You're right. It's a personal preference how you spend your money (cash). It's up to you whether or not you want to spend it with a lower return, or use it for a higher one..
Also, not sure how cash flow reduces risk in this case. You have $1.3M in equity at risk, with only $1.5M in leverage protecting it.

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Atul Mohlajee

Oak Park, IL · Member since 2014 · 285 posts · 114 votes

3y

My real estate income is not used for living expenses at all. I like to lower risk at this time. I can manage even if my cash flow goes to zero or $5000 below zero. I am not in expansion mode anymore due to personal preference as well as high property costs as well as high interest rates.

0 Reply

Timothy Howdeshell

Investor · Fresno, CA · Member since 2016 · 222 posts · 237 votes

3y

I don't disagree with the math, but there are some large assumptions baked into the original post.

First, the majority of the return is all appreciation. It assumes an average appreciation rate of 5%/year. We are pushing up against an affordability crises and I don't think assuming higher appreciation consistently is wise when making purchase decisions. If it works out, great. But to me, this just feels like speculation and gambling. What if the property ends up down 10%, or even flat in 5 years? Now you have lost money on cash-flow and value.

For those with Bigger Pockets (see what I did there), playing the speculation game can be safe enough and profitable relative to their overall financial position. But for most starting investors (most of this site), they need cash-flow to continue acquiring or to live on.

At the end of the day, some markets are better for some things than others. In 2023 flips have been working well, while buy and holds have suffered. The wise investor has many tools in their toolbelt to profit regardless of the overall market.

1 Reply

Timothy Howdeshell

Investor · Fresno, CA · Member since 2016 · 222 posts · 237 votes

3y

Quote from @Atul Mohlajee:

I invested $2800000 on rental real estate between 2003 and 2021 mostly between 2011 and 2016, out of which I have paid off $1300000. Current value of real estate is $5000000, and cash flow is $10000 per month plus very conservative estimate as it may be around $120000 even. It is personal preference that I started paying off because since 2018,cash flow has been very hard to find, so I did not want to expand anymore. Currently I am in the process of paying remaining $1500000 that might take years. I also have W2s income to help with payments. I stopped expanding when cash flows dried out because cash flow reduces risk and this was a side gig for me always.

Hi Atul, sounds like you're doing quite well. Just curious, if you have $5m and are only making $10,000/month it sounds like you'd be better off liquidating as you're only at a 3.4% return on equity. Surely you can get a higher return elsewhere. If it is $120,000, and this is a side gig, you should be able to pay this off in like 1.5 years.

1 Reply

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

3y

Quote from @Atul Mohlajee:

My real estate income is not used for living expenses at all. I like to lower risk at this time. I can manage even if my cash flow goes to zero or $5000 below zero. I am not in expansion mode anymore due to personal preference as well as high property costs as well as high interest rates.

You're spending more money than you are getting in return.

0 Reply

Atul Mohlajee

Oak Park, IL · Member since 2014 · 285 posts · 114 votes

3y

You are right. I could sell all and be fine and totally stress free. I choose to hold because in addition to $10000-$12000 cash flow per month, there is mortgages payoff of $7000/month (most are 15 year mortgages.) Appreciation at 3% is $150000/year which is about $12500/month although it has averaged 5% appreciation for most properties. In addition to that, this cash flow is taxed at a lot lower rate than my W2 incomes. Real estate helped me with financial stability after immigrating to Chicago in 1986 with $15 ( It was actually $20 but spent $5 on pastries at the layover airport).

7 Reply

Anna Cerda

Member since 2023 · 26 posts · 5 votes

3y

@Andrew Postell Thank you for the thoughts on this topic. I think overall real estate is so much more than just numbers but management skills. Markets change but one thing stays constant everyone needs a place to live and there are many options, so make your option the best in the market.

0 Reply

Chad S.

Rochester, MI · Member since 2014 · 88 posts · 50 votes

3y

@Andrew Postell

Great post. I agree with everything you said. I would only add that all the cash flow and appreciation is going to be tax free. That to me alone is worth it.

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Marcus Auerbach

Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes

3y

There is a correct balance between cash flow and equity play. For most the right strategy is to go heavier on cash flow in the first years, a little heavier on equity later. Cashflow is like oxygen, you need it to survive. But cash flow does not make you wealthy. The notion of buy some rentals and travel the world is just one of these things: too good to be true.

For some context: I have been investing in Milwaukee for almost 15 years and have seen this play out in real time. A few months I had an older gentlemen on our RPA lunch & learn calls asking me about chash flow. The topic was how to make a million in RE in about 8 years.

He said he owns and operates a portfolio of I think he said 50 units in a low income area for now over 30 years and he said he is not even close to a million to retire on: he was pretty upset, so we looked into it a bit. He makes great cash flow, but he spent most of it on capex and operating cost (like turnover rehabs, evictions and other losses). So basically he was treading water for 30 years.

Bottom line: you need a good balance between CF and equity, can't be all one or the other.

3 Reply

Billy Daniel

Rental Property Investor · Russellville, AR · Member since 2014 · 688 posts · 509 votes

3y

I think it's important to consider your personal goals and current positioning before you read too much into this post. Buying with positive cash flow is always the best solution. While the current market makes this tough, the positive cash flow is out there. Sure, more seasoned and experienced investors could handle a negative cash flow, but the majority of novice investors can't. There are too many factors to consider that the investor has no control over. What if prices go down? What if the HVAC goes bust? What if your tenants flood the kitchen?

Be smart and get really good at due diligence!

1 Reply

Chad S.

Rochester, MI · Member since 2014 · 88 posts · 50 votes

3y

@V.G Jason

I like what you said about buying 5 quality properties instead of 15 that aren't quality properties. That's exactly what I did. I took my time to aquire quality properties that rent easily and are well maintained. They didn't cash flow alot at first but I also don't have to set aside alot of money for capital expenses. Now they cash flow very good and I can carry these well maintained properties into retirement in 4 years at 60 years old to supplement my retirement.

1 Reply

Chad S.

Rochester, MI · Member since 2014 · 88 posts · 50 votes

3y

@Atul Mohlajee

Well done.

1 Reply

Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

3y

this debate rages on.

one thing the cash flow is the only thing important statement has done from what I have seen.

It has encouraged beginner investors to take on high to higher risk assets without the knowledge or ability to run them.

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Steve Vaughan

Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes

3y

Quote from @Atul Mohlajee:

You are right. I could sell all and be fine and totally stress free. I choose to hold because in addition to $10000-$12000 cash flow per month, there is mortgages payoff of $7000/month (most are 15 year mortgages.) Appreciation at 3% is $150000/year which is about $12500/month although it has averaged 5% appreciation for most properties. In addition to that, this cash flow is taxed at a lot lower rate than my W2 incomes. Real estate helped me with financial stability after immigrating to Chicago in 1986 with $15 ( It was actually $20 but spent $5 on pastries at the layover airport).

Your story is inspiring, Atul. I just love how the still need a paycheck people chime in like they're teaching you opportunity cost and portfolio optimization or something. Keep doing you.

I held my longtime low LTV low ROE portfolio of smalls and mids for the same reasons as you until last year. I sold on owner contracts because we don't have w2s. Earning interest is just ordinary income pretty much, so holding for tax purposes makes sense while still working.

As to buying for CF, my expensive market had me shift to buying smalls for equity capture 9 years ago. We should all strive to not pay retail, but I don't think buying your appreciation up front is talked about enough.

Smalls for equity capture, larger multis for CF. Asset type can matter.

2 Reply

James Hamling

Real Estate Broker · Minneapolis, MN · Member since 2011 · 5k+ posts · 6k+ votes

3y

@Andrew Postell I am in 100% agreeance with you, and, I also get bombarded with the exact same dismay and arguments as your getting every time I share my stance, and especially when I share the math of it all, and if I share historical numbers, well it seems to send people into full frothy-mouthed rage for some reason.

The big one I hear from people is "your speculating, what-if what-if what-if, how do you know it will appreciate". Well, historical data for 1. Any decline has been in short duration. yes, a handful of years IS short duration in the time lens of real estate.

But going a step further; Economics.

Price is based upon affordability, yes? Ok, and what is affordability based upon? Incomes, correct? So as median incomes go UP, affordability goes UP, and thus median real estate prices go-UP.

Now that we have the basics down, how is it I can feel comfortable in this time of chaos with projecting APPRECIAITION, yes today, now, 9/28/23 YES I am forecasting APPRECIAITION not just probably but with 98.999% certainty. How you say? WAGE INFLATION.

What's going on right now today? Open your news feed, put on that VPN and just scan the news as a whole. We have unions left right and center striking and getting new contracts with SIGNIFICANT wage inflation. In all job sectors we see Wage Inflation galore.

And as sure as the sun rises in the east and set's in the west, wage inflation INCREASES market economy prices, that includes rents and median pricing of real estate just as much as tooth paste and pickles.

Now here's the kicker I keep warning people about but very few seem to be hearing.

The speed at which mortgage rates have risen, NO not the fact of where they are but the MENTAL CONDITIONING of going from where they were, to where they are, in such time window, has "frozen" activity. Both buyers and sellers.

Now, take those 2 ingredients and throw em in a blender and what-da-ya-get? Because here is the thing, as with ALL Mental Conditioning of such, things thaw over time, people move into acceptance, it is the mental process. And as people move into acceptance it is a compounding "acceptance" phase. So add that, with INCREASED affordability, as it washes through economic system and what do you get?

Yup, a grade B+ recipe for pricing SURGE, not decline, which would be an appreciation surge.

Now, if looking for grade A, add in a reduction in that one-limiter, mortgage rates. Oh-man that would just fuel it all the more.

And, even further, let's pretend were in, oh-say, an election year for some big post like POTUS, and let's "pretend" it's hotly contested by the powers that be. Just imaging if they started stimulus to "pump" the economy to own the success?

Appreciation is mathematical. It's not some apparition of guess work that once in a blue-moon rears up like Nessy, that we must guesstimate when we may see it again next to try and catch. No, to the contrary appreciation IS the norm, and for not just years or decades but centuries.

Appreciation is the singular most stable, reliable, known and projectable metric in real estate. With intermittent blips of decline. So what do you do if in one of those blips, DON'T SELL, it's just that simple.

'08' was the second biggest collapse in the history of the nation. An event like that has happened a grand total of 2 times, EVER. Not acting on REI because of a fear of a '08' repeat is ludicrous.

While cash-flow is great, cash-flow matter, it IS by-fact just 1, ONE of the profit streams and it is by fact the LEAST helpful of the profit streams in GROWING a portfolio. Don't believe me, run the #'s. If looking at average down needed of say $50k, how long do you need to "save" to get down for next property? And waiting all those years, now factor in cap-x impact of that time eroding the savings. Factor in the market appreciation increasing needed down for next and with it, more time delay.

It's a fact of math, the #1 strategy for growing a portfolio has been now, as ever, Pyramiding, which is all about appreciation growth and utilization, where cash-flow is operational focus not portfolio growth.

None of this advocates making bad/dumb buys, but even those, if done, can be converted to decent or even good with the power of appreciation and time.

The most powerful tool in REI is Leverage, because it empowers the most powerful profit potential Appreciation, to an amplified measure.

6 Reply

Adrian StamerPro Member

Real Estate Investor & Agent · Richmond, VA · Member since 2013 · 319 posts · 167 votes

3y

For everyone saying cash flow doesn't matter, how do you explain this to the bank with minimum DCSRs on the loans? Is everyone here just buying SFH or using creative financing?

I understand I can just put a larger down payment down to force enough cash flow, but every dollar more down reduces returns further

2 Reply

Mark S.

Real Estate Investor · Saint Paul, MN · Member since 2017 · 543 posts · 474 votes

3y

@Joe Villeneuve There are a ton of people who’ve been saying, or at least, implying, that it’s easy to make money in real estate. and that you’re foolish to waste your money on college, stock, investing, etc. Just buy real estate.

0 Reply

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

3y

Quote from @Mark S.:

@Joe Villeneuve There are a ton of people who’ve been saying, or at least, implying, that it’s easy to make money in real estate. and that you’re foolish to waste your money on college, stock, investing, etc. Just buy real estate.

...and,...?

2 Reply

James Hamling

Real Estate Broker · Minneapolis, MN · Member since 2011 · 5k+ posts · 6k+ votes

3y

Quote from @Mark S.:

@Joe Villeneuve There are a ton of people who’ve been saying, or at least, implying, that it’s easy to make money in real estate. and that you’re foolish to waste your money on college, stock, investing, etc. Just buy real estate.

1 Reply

V.G JasonPro Member

Investor · Member since 2022 · 3k+ posts · 3k+ votes

3y

Quote from @Timothy Howdeshell:

I don't disagree with the math, but there are some large assumptions baked into the original post.

First, the majority of the return is all appreciation. It assumes an average appreciation rate of 5%/year. We are pushing up against an affordability crises and I don't think assuming higher appreciation consistently is wise when making purchase decisions. If it works out, great. But to me, this just feels like speculation and gambling. What if the property ends up down 10%, or even flat in 5 years? Now you have lost money on cash-flow and value.

For those with Bigger Pockets (see what I did there), playing the speculation game can be safe enough and profitable relative to their overall financial position. But for most starting investors (most of this site), they need cash-flow to continue acquiring or to live on.

At the end of the day, some markets are better for some things than others. In 2023 flips have been working well, while buy and holds have suffered. The wise investor has many tools in their toolbelt to profit regardless of the overall market.

Ok, let's just think about this deeper. Where do you see inflation for bal-decade? In my view, conservatively it'll not really be lower than 3% but probably averaging 4-5%. With a funds rate staying around 3% give or take a percentage. If you see differently, that's fair. Let's go with what the "target" is--2%. At 2% inflation with a fed funds staying at around 3%, you're appreciation is no longer 3-5%. You're now working at the midpoint of 5% appreciation.

With premium parcels of land taken up, you can bet less supply of certain areas would mean even higher appreciation. So call range now 4-8%(mid point 6%) conservatively. Now what would cause a mass supply of houses & land-- cheap materials AND lots of sellers. What has to happen for that? Very low rates? What happens to your house you bought in 2023 at 7% if really low rates happen?

The bet in 2008-2022 was cash flow. If there's a downturn in the market, you don't keep that cash flow. Your renter likely can't pay; so that argument is moot. The land is the value. Evaluate the parcel of land then do a cost to build ratio on it. If it exceeds the price of the house, you'll be safe. You'll be safer if you keep heavy reserves and/or deleverage(this is a math issue, but I am speaking behaviorally here). The bet in 2023- fwd is persistently higher inflation so grab premium areas not volume of properties. This is where appreciation will make sense.

10 C/C+ houses bought in 2023 vs 2013 will yield significantly lower cash flow. Buy 4 B+/A- one's instead. Lower your capital expenses, vacancy, etc., and bet on premium areas. The shape of real estate has shown premium areas go up, bad areas go to the bottom.

2008-2022 made a bunch of "investors" in real estate invest based off a return of $4800/annually missing the tens of thousands it may cost them to maintain the house, the tenants, etc. So if cash flow is your narrow focused goal, be prepared to be always be leveraged, invest in sub prime areas, deal with massive amounts of headaches/stress, and have consistent periods of no cash flow.

1 Reply

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

3y

Quote from @Mark S.:

@Joe Villeneuve There are a ton of people who’ve been saying, or at least, implying, that it’s easy to make money in real estate. and that you’re foolish to waste your money on college, stock, investing, etc. Just buy real estate.

So what's your point?

0 Reply

Ryan ThomsonBusiness Member

Real Estate Agent · Colorado Springs, CO · Member since 2018 · 1k+ posts · 1k+ votes

2y

@Andrew Postell I agree.

Cashflow has been pushed hard by the FI movement so that people can work towards quitting their jobs. The problem is the timeline is often way off. They are hoping to do so in 1-2 years. Which was possible when rates where 2.5%. Not anymore.

I agree that calling a property a good investment bc it makes you an extra $150/month ($1,800/year) is wild. It's certainly not going to make you rich. The cashflow pales in comparison to loan paydown and appreciation. You captured that well.

I am trying to get my clients in Colorado Springs to see that if the home is currently negative $100 in cashflow each month (-$1200/year) then that is part of the investment. You invest your down payment and you invest into the house each year (maintenance and negative cashflow and vacancy, etc) with the long term expectation that rents will rise and your home will appreciate.

When you take all of the ways real estate makes you money into account (loan paydown, appreciation, tax advantages, and cashflow(even negative)) your ROI is STILL better than most of the other investment opportunities out there.

You obviously have to be able to afford the extra monthly payment. But ruling out an investment because it doesn't pay you monthly seems short sighted.

This obviously makes more sense for house hackers who have to live somewhere and can look at that negative monthly payment as the "rent" they are no longer paying.

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Andrew PostellPro Member

OP

Lender · Fort Worth, TX · Member since 2016 · 8k+ posts · 6k+ votes

2y

@Ryan Thomson yeah, I have to reset expectations quite often. Usually a real estate investor is numbers driven so feel free to use any of those numbers above if you need. You can even send them that article. Sometimes having someone ELSE say these things helps too...so make sure your partners are on board with the same messaging as well. Here to help if you need anything. Thanks for replying!

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CASH FLOW: Why you have been analyzing your deals all wrong.

CASH FLOW: Why you have been analyzing your deals all wrong.

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