Why getting into real estate primarily for cash flow is wrong - and even dangerous

Milwaukee, Wisconsin
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Why getting into real estate primarily for cash flow is wrong - and even dangerous

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

Hear me out.

Over the last years, more and more of the BP discussions circle around cash flow. As LTR was getting harder 2018-2020 STR became the new thing everyone started chasing. Until that started getting difficult. So now what?

The idea aspiring investors get mesmerized with is basically to start in real estate and somehow build a portfolio out of thin air. And gurus are happy to feed that dream. Basically, they suggest to buy a property with very little money, collect the cashflow, then refinance to pull money out of the property, buy more real estate for more cash flow and quit the W2 they hate.

The first flaw is that a lot of the books written before 2020 will tell you to analyze more deals until you find one that cashflows. The problem is that the market landscape has fundamentally shifted. Back then looking at more deals would eventually get you a "quality" deal, today it will get you a deal in the hood. And as you can read here on BP this is probably the number one recipe for financial failure. Best case, you learn a lot, survive financially and trade up. You certainly won't achieve any significant wealth in that asset class. The second flaw is the idea that you can refinance your way to wealth - that has always been very risky even with low interest rates.

It is called in-vesting for a reason. You are putting money in. Let me explain.

The goal of real estate investing is to allocate your capital in a low-risk investment that grows your net worth predictably over long periods of time - think at least decades if not longer! The superpower of real estate investing is equity growth: the asset appreciates, while inflation and loan payments erode the underlying debt until you own the asset free and clear and can leverage it again. When you run numbers in a BP calculator you can see quickly that equity gains DWARF cash flow. So, for anyone who wants to go into real estate primarily for cash flow, they have not yet understood the concept! 

Don't get me wrong:  cash flow is still an important factor, it keeps the lights on, it pays for repairs and upgrades. And eventually, it helps you buy more real estate (until when you start milking your portfolio to cover your living expenses).

If cash flow is what you want, buy a business. 

A business has an inverted financial profile: it is literally designed for cash flow. That's the main objective. And not just $200 per month per door (which has been the long-standing average, at least here in Milwaukee) Yes, you can also create equity with a business, if you are growing it to a size where it becomes a sellable asset, you replace yourself, hire a manager and a team of workers. But ask anyone who ever sold a business: it is not easy!! That's why many businesses just close instead of being sold.

Real estate investing provides a lot more creative angles than the stock market, but on a conceptual level, nobody would seriously attempt to replace their W2 income in a few years by investing a few thousand dollars in the stock market. In a way, STR is a hybrid because while real estate is part of it, you are really running a one-room hotel.

So if you are an aspiring real estate investor, the first question you should ask is where do I have a consistent source of free cash that I can use to invest? That can be excess income from your W2 job, or it can be a business you run on the side. Then you can take that cash and buy quality real estate, accumulate the cash flow and grow your portfolio-wide before you grow it deep - meaning paying off loans. 

The day you start siphoning cash flow out of your real estate portfolio, you are stifling future growth. So you will have to decide if your portfolio has grown enough to support your goals and dreams at that point. Otherwise, keep pushing!

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Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
1y

The CF mistake REI make is they think you can accumulate CF properties starting from the beginning. You can't, and you shouldn't. Even if you could (and you can) find a lot of PCF deals out there, how do you buy them? It's not like you have an unlimited source of DP's available to you, and buying all cash is foolish. If you think you are accomplishing something just because an all cash deal is PCF, it's an illusion. All you are doing is playing catch up to your cost,...you cost being the cash you put into every deal. That's your cost. The more you put in, the more you have to recover before the PCF is actually a profit. That's one of the big reasons to leverage. You can spread your cash out, and each property then accumulates CF to recover the same cash you might have used on one all cash deal.

Buying for accumulating equity is also an illusion.  The equity is actually what you are paying for the property.  It's a form of cash that is locked up and useless to you.  Those that say it has value, I'll give you all of my sports trophies I've accumulated over the years.  I'll even through in my daughter's.  They are both the same value.

The power of the equity is the PV it buys.  When you initially buy a property, ad 20% DP, you are buying a property that's worth 5 times what you are paying for it.  As the equity grows, it's diluting the power of that equity since it grows on a 1 to 1 ratio to the PV growth.  Remember, that equity started out as a 5 to 1 ratio.

Here's my take on the roles of CF and equity, and why I say you must have both:

Role of CF - To accumulate within a property to equal the cash you put into it. As long as you have PCF, this really means you have a clear property since the tenant is paying for the rest.

Role of Equity - To grow from appreciation to a point where the growth is equal to the original equity, thus doubling it.

When both things occur (order doesn't matter), I sell.

Banking only on either CF or equity is a loss.  You have to have both, and to say you can't just means you are looking in the wrong markets, and/or using the wrong strategies.

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  • Marcus Auerbach
    OP
    Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
    1y

    To your point @V.G Jason I think it's always good to stress test a portfolio in XLS and see how bad it has to get before it needs to be subsidized to stay afloat and weather a storm. 

    Nothing wrong with considering disposable W2 income also available cash flow for this scenario. IMO it is perfectly acceptable to throw a couple grand from a strong W2 as a temporary plan B into the mix - as long as the portfolio is small that will go a long way in an emergency. But if you have a $10M apartment complex going sideways, don't even waste your W2 money. Obviously.

    2Reply
  • V.G JasonPro Member
    Investor · Member since 2022 · 3k+ posts · 3k+ votes
    1y
    Quote from @Marcus Auerbach:

    To your point @V.G Jason I think it's always good to stress test a portfolio in XLS and see how bad it has to get before it needs to be subsidized to stay afloat and weather a storm. 

    Nothing wrong with considering disposable W2 income also available cash flow for this scenario. IMO it is perfectly acceptable to throw a couple grand from a strong W2 as a temporary plan B into the mix - as long as the portfolio is small that will go a long way in an emergency. But if you have a $10M apartment complex going sideways, don't even waste your W2 money. Obviously.

    I am not a huge fan of stress tests or risk metrics. Not a big believer than you can quantify risk.

    To really manage physical asset risk, you have to go for quality over quantity. Phys assets are a whole different scheme of investing, whether it's toll roads, timber, wells, etc., it's really less about diversification and more about concentration & systems in place. I know that goes against most portfolio advice, and I won't get into all that but just the way I look at it. 
    0Reply
  • Albert Bui
    Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
    1y

    The "real life," cashflow for me has been a decade + journey especially when you're referring to consistent predictable cashflow spanning an accumulation of purchases of apartment units. 

    I never really made any money in excess of capital contributed such that I would deem it any decent rate of return ( IE I have min criteria of 8% cash on cash and I was making less than this) till about year 2-3 or after on each real estate property. These were mostly 2-12 unit properties so smaller MFR's. The initial year of each purchase was always a series of capital contributions to get it up to speed or get it going. Of course there were properties which cashflowed day one albeit a lot less than my proforma but I would still have to do lots of work.

    I would preface I was buying class C to B- type of real estate 1900-1980's product. The older the product the more the capX generally required to get it up to speed from studs out renovations to basic cosmetic upgrades.

    The OP posts that getting into real estate for cashflow is "wrong." To which Id say it depends on when you bought, how you bought, what you did to the properties CapX wise, and how you managed. Depending on where you purchased the properties a different strategy or approach might be needed to buy for cashflow. 

    I would also agree a business is much better for cashflow (stabilized, operating well, for on going CF).

    Real estate does cashflow well but it wasnt overnight and requires many units stabilized and maintained to keep cashflowing regularly. However "regularly," is not regular either because it can waver up and down quite a bit too depending on how many move out/unit turns you have per month too. I've experienced swings where its 50% less cashflow than the prior month due to a month of multiple apartment turns all hitting at once versus a stabilized month. 

    In Summary, I would say cashflow works its not easy and may take a lot more capital contributions than you think. However, is cashflow wrong and dangerous for most ? Perhaps, but nothing of value was ever obtained easily otherwise it would simply not be such, valuable.

    0Reply
  • Marcus Auerbach
    OP
    Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
    1y
    Quote from @Albert Bui:

    The "real life," cashflow for me has been a decade + journey especially when you're referring to consistent predictable cashflow spanning an accumulation of purchases of apartment units. 

    I never really made any money in excess of capital contributed such that I would deem it any decent rate of return ( IE I have min criteria of 8% cash on cash and I was making less than this) till about year 2-3 or after on each real estate property. These were mostly 2-12 unit properties so smaller MFR's. The initial year of each purchase was always a series of capital contributions to get it up to speed or get it going. Of course there were properties which cashflowed day one albeit a lot less than my proforma but I would still have to do lots of work.

    I would preface I was buying class C to B- type of real estate 1900-1980's product. The older the product the more the capX generally required to get it up to speed from studs out renovations to basic cosmetic upgrades.

    The OP posts that getting into real estate for cashflow is "wrong." To which Id say it depends on when you bought, how you bought, what you did to the properties CapX wise, and how you managed. Depending on where you purchased the properties a different strategy or approach might be needed to buy for cashflow. 

    I would also agree a business is much better for cashflow (stabilized, operating well, for on going CF).

    Real estate does cashflow well but it wasnt overnight and requires many units stabilized and maintained to keep cashflowing regularly. However "regularly," is not regular either because it can waver up and down quite a bit too depending on how many move out/unit turns you have per month too. I've experienced swings where its 50% less cashflow than the prior month due to a month of multiple apartment turns all hitting at once versus a stabilized month. 

    In Summary, I would say cashflow works its not easy and may take a lot more capital contributions than you think. However, is cashflow wrong and dangerous for most ? Perhaps, but nothing of value was ever obtained easily otherwise it would simply not be such, valuable.

    My experience is similar, Albert. It always takes a few years to establish cash flow, especially with the 1960s properties we typically buy. My strategy has changed over the years from only fixing what's necessary to fixing everything (and do a full remodel), which of course takes cash up front. But I'd rather frontload it and be done with it. It also results in a nicer product, attracting better tenants.

     Parts of our portfolio are over a decade old and of course they cashflow very well at that point. This was not the case in year 1 for many. You could also say the more equity you have in a property, the better the cash flow. It does not matter if that is equity created over time or from a XL down payment.

    My point is that new investors want cashflow NOW. They don't want to wait 10 years. And in their quest to get to that they turn to high cashflow properties, which is another way of saying cheap hood properties. And that's where they get in trouble.

    I have never taken money out of our REI portfolio to cover living expenses. In fact, just the opposite. I could have, but instead, we have started to point that cashflow stream against individual loans and pay them off in full one by one. I did quit my corporate job in 2015, but I started working on building a business. But the investing landscape has changed and I think in 2025 it is even more difficult to "buy" RE cashflow, that's why I am suggesting to buy or build a business, even if it's just a couple grand from a TikTok shop.. that's equivalent to 10 doors

    1Reply
  • Marcus Auerbach
    OP
    Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
    1y

    It's not missed as long as you 1031 exchange it. But if you are happy with the property and it's trajectory, why would you generate work for yourself and exchange it?


    @Tom O. you could also consider this: instead of paying off loans with CF, hold your leverage position steady. I have written about this quite a bit on another post. If you portfolio value goes up 3% and you have increased rents, you can just refi (or LOC) an equivalent amount of money out of your portfolio, which is cash free and you are free to blow in Vegas if you like.

    Every ultra-conservative-Dave-Ramsey-type financial advisor will tell you to do the exact same thing with your 401k - spend 4-5% every year (presumably just under portfolio growth rate) and don't draw off the principal. You can do the same with RE. And then pass it on to your daughter stepped up. 

    You can actually give some of the equity draws to your daughter now, so she does not have to wait..

    1Reply
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