Real Estate Investor · Greensboro, NC · Member since 2008 · 6 posts · 0 votes
Seems like there are two methods which all the books, videos and articles put forth: Cash Flow and Appreciation.
Landlording seems to lend itself to the Cash Flow side of things, with possible returns several years down the road when the property has appreciated.
So take this property that I'm looking at as an example:
4-unit apartment selling for $209,900.
Currently fully rented for $580 each unit.
Now, I'm a newbie, and if I'm doing the calculations right, this seems like a good deal with some real cash flow.
But I can't help but get caught up with the part that I need to plunk down $40k plus closing costs just to get into the deal.
So I am tying up my $50k to get about $1,200 per month, or about $15,000 per year. So I don't even get my original $50k back for over 3 years.
Now, the first 3 years I will be building equity in the property that really my tenants will be paying for, as well as some cash flow. After that 3 years, I could either sell it and take the profit or keep it and continue getting cash flow for as long as I own and maintain the property?
Is this the proper way to be evaluating a potential deal?
I'd appreciate any feedback, especially if you are good at more complicated calculations like ROI and the TVM.. things which make my head hurt!
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
17y
You should post more details on the investment to get more complete responses:
How old are the units?
Any repairs/upgrades necessary?
What are the area demographics?
What has been going on in the values in this particular area?
Your $40k down estimate is also low. Most lenders today want 25% down on quadplexes + closing costs and impounds.You are looking at something closer to $60k down, assuming you are using traditional leveraging.
You will probably here from someone that this is a terrible deal. They will explain that your financials will be this:
$2320 Gross income
$1160 Less operating expenses
$ 910 Less mortgage payment (approx)
-----------------
$ 250 monthly cash flow
It is hard to say, judging from the lack of information, if this deal is a winner or not. You also need to inform us of your exit strategies, goals, and any reserves you may or may not have.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
Tbd,
You are right that there are many ways to make money with real estate. Cash flow and appreciation (speculation) are two of them.
With a rental business, you MUST have a positive cash flow to survive (or you might have a big pile of your own money that you can spend each month to offset your losses).
Real Estate Investor · Greensboro, NC · Member since 2008 · 6 posts · 0 votes
17y
The building is 8 years old and doesn't need any major repairs... just pressure washing the siding, replace a few broken window screens, and possibly a fresh coat of paint on the interior.
In this area, prices have held steady. Most properties are taking longer to sell, however.
Is the main difference between the way nationwidepi and MikeOH ran the numbers is that MikeOH figured the down payment into the monthly mortgage payment?
And my goals are to be in this for the long term. I would like to take profit from my other business and invest it. I'm not any good at stocks, which is why I am looking at real estate. I'm young enough that I don't care to spend the profit from my main business on material items. I can hunker down and make it grow for me.
How much better would the deal look if I got the property for $189,900? The realtor I spoke to said they are going to drop the asking price.
And the 50% rule is just an estimate as to what the monthly expenses are going to be, right? So if the expenses come in lower, then I can keep that extra that's been set aside?
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
17y
As far as the numbers Mike posted, yes, he calculated the entire purchase price for the mortgage, rather than just the actual mortgage. The thought process there is that there is a "cost" to the $ invested. I have a different philosophy in that their is not a cost to the $, rather a decision level to make dependent upon the return of that $. Basically if your COC return meets your criteria level, you do, and if not you do not.
Yes the 50% rule is only an estimate. Your particular property, in your particular area may very well operate with a lower expense ratio. Be that as it may, you do want to have a reserve account for the larger capital expenses that will occur over a long period of time for items such as roof replacements, etc. Since you have a long-term hold strategy here, you need to calculate that figure into your project.
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y
Add my $.02 to the conversation. I've always taught that there are 4 benefits to owning real estate.
1. Appreciation
2. Tax savings
3. cash flow(if any)
4. Principal paydown
IMO, the first 2 are miles ahaead of the other 2. If you can allow your real estate to grow, and not live off the cash flow, keep another job, you'll succeed in creating wealth. It is automatic as listed above.
Arlington, VA · Member since 2008 · 9 posts · 0 votes
17y
How can you justiyfy appreciation as being "miles ahead" of principal paydown? The way I see it, principal paydown is at least guaranteed equity that you will be building whereas, as MikeOH said, appreciation is speculation.
As long as tenants are paying rent and paying your mortgage you are gaining equity. Appreciation is a great benefit indeed, especially on high ticket and highly leveraged items such as real estate, but it is highly variable (unless youre looking over a very long timeframe). I would rather know I am definitely building wealth rather than possibly.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
17y
Jimbo, is it speculation that the sun will rise tomorrow. Technically, yes, but we all know it Will happen.
Appreciation over time has always occurred, so branding it speculation is inappropriate.
Speculation in my opinion, is the purchase of an investment with a short term expectation of gain from appreciation.
That said, Rich's comment that appreciation and tax deductions are miles ahead of cash flow and principle reduction stems from the actual amounts generated. Cash flow of $100 per door per month is miniscule compared with large chunks of equity gained over theyeras, particularly when you use leverage. Principle pay down is "guaranteed" but it is also a small amount compared to appreciation and tax deductions. Tax deductions are also "guaranteed" and can be quite large which is why it is one of the two that trumps the rest.
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y
I couldn't have said it better Will. The avg appreciation rate NATIONALLY for the last 59 years is 5.34%. Some areas have been higher obviously.
At an interest rate of 7% lets find a building that breaks even after rent and all expenses. To obtain a $100 monthly cash flow, all I need to do is put down another $16,000 in cash.
In my area, I can take the $16K and buy a SECOND rental. at break even.
After 5 years scenario;
#1 House is now on paper worth $129,700 and I earned maybe 8K in cash flow. We'll assume none of that was taxable. I also had principal paydown of maybe 4K.
total benefits
1. $29700
2. $8000
3. 4,000
Total $41,700
Property in example was $100K at start
Scenario # 2
House # 1 appreciated $29,700
principal paydown $4K
taxes saved 1K per year=$5k
total======$38,700
Looks pretty close.............oops I forgot the SECOND home I bought with the 16K.
House # 2= $29700
principal paydown $4K
Taxes saved $5K
total $38,700
Total of scenario 2 is $77,400 compared to "cash flow" scenario of $41,700.
I'd say earning almost TWICE as much qualifies for my previous definition of "miles ahead"
Remember that depending on the cash flow and your tax bracket, you don't get to keep it all.
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y
I DO !!!!!! In the middle of a book I wrote(my avatar) and NOT for sale, I have letters of apology from the irs reducing my taxes owed for 79 and 80 from over 600K down to 1K. They are sobs and I determined to not pay taxes again.
Last year I paid $234 and received eic of $120. Net taxes for the YEAR was $114. Only paid that to get 4 more quarters of qualifying for ss.
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y
Question on cash flow. If you don't need it to live on, give me a good argument for wanting cash flow on a property. It definitely seems that monopoly game as a kid was correct. Not cash flow but # of properties made you a winner. Convince me that real life is different. I'm ready to argue!!!
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
17y
I was told that you can't put food on the table with appreciation.
Of course, I do not buy that mentality as it seems to stem from the necessity of cash flow.
My only argument in favor of cash flow is this: If you have it, you most likely made a good buy decision and you most likely have a better ROI, and definately a better COC. Other thna that, Appreciation and tax savings are KING!
Arlington, VA · Member since 2008 · 9 posts · 0 votes
17y
Like I said, I do agree that appreciation is a great thing over a long period of time. That said, if you want to talk about leveraging funds to buy more investment properties then appreciation isn't always your greatest benefit.
Say you buy a property at 7% interest for 15 years at $100k. In 15 years at 5.34% appreciation it is worth about $218k. You would be able to refi to about $174k leaving you with 74k profit minus financing costs from appreciation. You would receive 100k from principal paydown.
On the other hand, you can own an asset free and clear, have a helluva credit line to buy other properties for cash, and get a very nice cash flow (I bet those rents appreciated too).
And while I agree that appreciation is the best benefit over a LONG period of time I can't agree with your example over a 5 year period. As you said, that 5.34% appreciation per year youre using is over a period of 59 years. I bet there are a lot of areas that won't see that over the next 5 years, wouldnt you agree? Using your example, at least I know I will be making 12k, of which 8k is liquid. Tax benefits are definitely great at all times though.
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y
No one can predict the future, that is why we look at the past. Times have changed and will continue to do so.
You changed the example and made assumptions that may turn out accurate or inaccurate.
1. You selected a 15 year mortgage. Most investors INTERESTED in cash flow would select 30.
2.Net refinancing funds are not your "profit" , neither gross nor net.
3. You're "assuming" this F&C home will automatically allow a refi to be obtained. There are many investors out there "RIGHT NOW" that can't find a refi.
4. You use a 15 year period for your comparison, and then question my return over 5 years. Be consistent and use same test period.
5. You must deduct for state and fed income taxes if property is F&C and this reduces your net by some %, while my example affords you opportunity to keep more of your income for additional investments.
I'd never represent that any 5 year period is adaquate to project a result.
Most experienced investors will look to the future value and tax benefits as the giant benefits of owning RE., while cash flow and principal reduction are minor.
Most of the gurus selling "cash flow" are preying on the individual that shouldn't be getting into RE in my opinion. They crank up their plastic for all these seminars, find themselves more in debt, no discretionary income left(after all the seminars)for investments, and need the cash flow to
survive. That is asking too much, imo.
I'll stand by my example and I've lived by it for nearly 40 years. It is the way to create true wealth.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
Whoa! There has been more bad information in this thread than anything I've heard in a long time.
First, inflation adjusted appreciation in home prices averaged 0.4% from 1890 to 2004!!! Home prices have historically barely outpaced inflation. The FACT is that we have been in a real estate bubble in this country since at least 1997 and now the bubble is STARTING to deflate. This deflation in home prices could literally go on for decades.
While we're talking about appreciation, let's look at two of the ways we pick up equity. Many of the people on this forum sell rental property to newbies at retail prices and with negative cash flow. There is nothing wrong with this approach, but the idea is they (the newbies) will get paid when the property appreciates and they sell the property. You'll note that the sellers got paid when they sold the property to the newbies. This is a pure speculation play for the newbies. If appreciation returns soon and we have another big real estate boom, they will be rewarded. However, if I'm right and the economy is in for a LONG correction, there will be further depreciation and it could take decades just to get back to even.
Let's assume that someone was following this appreciation theory and bought a property in 2004 or 2005 in a bubble area. At this point, that property may have lost 50% of it's value. Here's the question, how many years at 5% appreciation will it take this person just to get back to zero? ALMOST TWENTY YEARS! When you've lost 50%, you must then gain 100% to get back to even. So much for betting on speculation!!!
On the other hand, if you are buying property for cash flow, you MUST buy at a discount. I have bought a bunch of my properties at less than 50% of the market value and have posted the numbers on those deals. When you buy at a 50% discount, you've essentially got an immediate 100% appreciation on the property.
So, here's the choice. Buy property at retail with zero or negative cash flow and hope for appreciation in a time of unprecedented financial trouble...or buy at a big discount, get IMMEDIATE equity AND receive positive cash flow from the property.
I don't know about you, but I'll take the equity NOW and take the positive cash flow NOW! Why bet on appreciation when you can have the equity now?
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y
Lots to reply to here, and not enuff time. I'll reply to these ideas in detail shortly. I also pay cash for foreclosures, but not very many investors are able to do that, nor get them refinanced or even sold in this market.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
Oops, I forgot to comment on this.
The way that you get the $100 monthly cash flow is to BUY AT A BIGGER DISCOUNT, not put more money down. Putting more money down doesn't improve a bad deal. Putting $16,000 down is doing nothing more than just buying the cash flow, and I certainly wouldn't do that.
Real Estate Consultant · Member since 2008 · 792 posts · 30 votes
17y
Yes the 50% rule is only an estimate. Your particular property, in your particular area may very well operate with a lower expense ratio.
In my opinion, toying with expenses is the easiest way to "trick" yourself into a deal.
Just out of curiosity, how low would you estimate expenses for the "best" area? That sounds a lot like the "house is brand new so expenses should be lower" argument. How does that work out after 7 months and one bad tenant?
Cash flow vs. Appreciation is the most amateur argument in the history of real estate. A good deal is a good deal.
The property either services the expenses and the debt, or it does not. Screwing with the debt service numbers or expenses are all logical (but flawed) ways to justify an emotional decision.
You would be able to refi to about $174k leaving you with 74k profit minus financing costs from appreciation. You would receive 100k from principal paydown.
By the way, refi cash is not profit. It is more debt. If I borrow money to build a business, the borrowed money is not profit, it is debt. Real Estate is the same thing. It's not profit until you receive it as income in surplus of obligations, or you sell it. That's the only way to profit. Many, many people got smoked by the REFI game.
If you are new to the business, please run away from this thread.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
David - you're absolutely right. Pretending that your expenses will be better than hundreds of thousands of professional landlords across the country is a dangerous game. We've had a BUNCH of people on this forum claim that there expenses were lower than the 50% rule, but in EVERY instance when they posted the numbers, they were in the 45% to 50% range (which is the 50% rule).
AMEN! Paying retail for a deal is NOT a good deal (appreciation or not). Paying retail takes no effort and the reward is commensurate with that lack of effort. With even a little effort, it is almost always possible to buy a property at below retail prices.
Why buy a bad deal when you can buy a good one? I don't understand that philosophy!
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y
This is what I like about BP, a good exchange of ideas, normally without accusations. Just because someone has a different point of view, doesn't make it "bad info". If there is something incorrect, point it out, as will I.
First, in one post, going back to 1890 is very interesting but of little use. How about this, we split the difference.
This takes us to 1968 according to assn of realtors, should be long enough.
Now to address the reply from Ohio Mike.(I'll be Texas Rich).
To be fair, please don't insult the reader of BP by using the last 3 years as your sampling. Bit unfair. On that basis, I think I'll go to 9-11-01 and compare stock market. We dropped to that same benchmark yesterday!
Back to my passion, RE. Most investors are just beginning and I've seen too many think they can make a living out of cash flow . Big mistake. Cash flow normally comes from older distressed property in lousy areas, can you say Cleveland?
Price and terms are the keys. To get price, you need to offer something seller is willing to discount for, normally cash. To get terms, NORMally you pay a higher price. This is the way RE econ works. I've done both.
I also don't see the "bubble" referred to by a poster previously in the accompanying chart for the year 1997.There have been higher and lower years than 1997 before and after.
You'll notice on my bio, I believe in buy and hold, not selling to newbies at retail. I was a Broker in CA and CO in the 70's before retirement but not since then have I been licensed , but always active. The original post in this thread was asking about cash flow or appreciation.
My reply was to compare the 2 with all things included. Other posts make no mention of the effect of leverage instead of high % down or tax effects and/or benefits for investor. As an investor that has been around the block many times, I'll stick to my guns on this one. I assure you that SUCCESSFUL investors are very concerned about the tax benefits of RE.
Please don't think I'm against cash flow, I just think selling someone on that idea is not my cup of tea. Normally the cash flow is not there like projected, it is older property, tons of potential repairs, no depreciation left per se because of age and nearly no tax benefits. An investor should look at HIS or HER particular situation before thinking cash flow is the name of real estate. It isn't. It is very popular these days, just as No Money Down( book by a friend of mine, Robert Allen) was 20 years ago. Neither were beneficial to all investors .
I hope good conversations can continue without listing someone with a contrarian view as "bad information". I've been living it and teaching it for way too long to accept that definition. Again, if there was an inaccuracy in my post. please let me know. Have a great day.
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y
Couple thoughts to recent 2 posts
1. I never suggested paying retail.
2. "cash flow vs apprecition argument is amateur" Come on! The initial post in this thread was regarding exactly that and it was the posters'6th post. Evidently, he was interested in contrasting views and that was what he got.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
I do live off cash flow. Why is that a big mistake?
I have properties ranging from low income apartment buildings built in 1835 to nice SFHs built in 1998 and every single one of them cash flows. Some of them were distressed (or more accurately their owners were distressed) when I bought the property, but they aren't distressed now.
I totally disgree with that. To get price, you need to find a DESPERATE seller, you don't need to pay cash (although cash always helps). I almost always use bank financing, so I don't play the terms game and I certainly would not pay a higher price. Price and terms are not equal, even when the payment is the same.
You get tax benefits if you buy a good deal and if you buy a bad deal, so that is not an issue.
That's just blatantly wrong. A property built in 1835 is depreciated over the same 27.5 year period as a property built in 2008.
Why would anyone buy a rental property that has no cash flow when they could work a little harder (buy at a bigger disount) and have one that has more equity and cash flow?
Rich, how about explaining your business model? You seem to be advocating buying property with no cash flow and hoping for appreciation. I assume that you then sell the property to get the equity. Is that what you do?