Cash flow necessary for long buy and hold?

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Cash flow necessary for long buy and hold?

Chris Ruud
Thousand Oaks, CA · Member since 2017 · 11 posts · 5 votes

Hey everyone.  First time poster here, but I've been reading up on real estate investing and this site a ton over the last few months, and I'm hoping to purchase 1 or 2 properties in the relatively near future to buy and hold for a long time.  As in, I'm 30 now and I'd hope to keep them until at least when I'm 65+ and use the rental income to supplement whatever other retirement income I'd have, or potentially sell them at that time to fund retirement. 

My question is this:  For someone in my situation, really how important is initial cash flow?

Trust me I understand that having initial cash flow is preferable to not having cash flow, but as most of you know in my market (Los Angeles area) having initial cash flow is tough when rents are commonly nowhere near the 1% rule.  A 500K house would typically bring in around 2500-2800 in rent.

Here is my thinking, and I'm hoping someone can correct me if I'm seeing something wrong here.  Assume I buy a 500K house now, and my income matches my expenses exactly and am therefore at zero cash flow.  Let's also assume the absolute worst and this property never appreciates, and even worse I am never able to raise rents.  So I move along for 30 years making no monthly money cash flow wise.  

But at the end of this 30 years, I now have a 500K house owned free and clear.  I can sell it and have 500K cash.  So really I have made 500K in 30 years, which works out to be $16,666 dollars per year.  Making almost 17K per year doesn't seem all that bad to me, for the minimum amounts of time and energy required to manage a single house.

And of course, appreciation and rental income is highly likely to increase pretty substantially over the course of 30-40 years, which puts me in an even better situation.  In reality it wouldn't take long for me to be cash flowing, and by retirement I'd be cash flowing pretty well.  So in reality my total profit is more likely to be in the neighborhood of 1M or 1.5M, or could be more.

Again I'm not thinking that cash flow shouldn't matter to anyone, or that I shouldn't also try to get a great deal, just trying to understand my specific perspective.  It just seems to me that with an extremely long buy and hold, you can't really go too wrong. Thoughts?

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Allan Rosso
Investor · . · Member since 2017 · 173 posts · 84 votes
9y

@Chris Ruud I'm going to go off topic here, because you said something that caught my attention. There is no need to eat up the whole $100k you have available to invest, by putting 20-25% down on 1 - 3 houses. Of course it will take more work than simply buying a move in ready home at full value, but there are creative ways to invest, where you wont have to dip so heavily into the funds available to you. 

For example, my first rental was a bank owned home that had failed to sell at auction and was literally just sitting there. I purchased it for $77K with it needing a new roof, all new appliances, necessary plumbing work (which of course adds the need for drywall work), interior paint, carpet in three rooms, among other things. Even with all the necessary repairs, it appraised for $114k. I got a construction loan, and after everything was said and done, I was about $92K in. Because I had so much equity before I repaired it, I was able to finance the closing costs into the new loan, once I refinanced out of the construction loan. Virtually the only out of pocket expense was the original inspection, as well as lots of little things here and there that I paid for myself, rather than charging to the construction loan. 

I understand deals like these are not very common, and I feel extremely fortunate to have had it come my way. I was actually thinking I was going to end up having to pay for the closing costs myself, before I knew it could be financed into the mortgage, but I would rather pay 3-6% in closing costs out of pocket, than a 20-25% down payment on a move in ready house.

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  • James M.
    Rental Property Investor · Seal Beach, CA · Member since 2016 · 115 posts · 85 votes
    9y
    I love your train of thoughts and I am right there with you. I am a new investor as well, so I'm interested to see what some of the experienced guys have to say.
    0Reply
  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    9y

    I don't see returns high enough to justify paying CA prices. I would look elsewhere or consider an alternative such as a REIT, a HML fund, etc. There are other avenues to invest besides your own back yard.

    0Reply
  • Val J.
    Rental Property Investor · DFW · Member since 2015 · 89 posts · 36 votes
    9y

    I too like your thinking since I'm older and near retirement age. BUT, have you considered what you will do if you need to pay for a repair or if the tenant moves how will you fund the mortgage since your cash flow is negative? Like you I'm new to this and I've often wondered myself about the rule/advice from seasoned investors to set aside 50% of the monthly rent for expenses that without a doubt will happen sooner but hopefully later.

    1Reply
  • Chris Ruud
    OP
    Thousand Oaks, CA · Member since 2017 · 11 posts · 5 votes
    9y

    John, thanks and yes I've thought about investing elsewhere.  I guess from a numbers perspective, if I have 100K to invest, it does make sense to put that 100K towards down payments on 3 properties in Texas or Florida, and be cash flowing instantly, as opposed to 1 down payment here in California and not be cash flowing.  

    I guess the question is then, for a new investor does that extra initial cash flow make it worthwhile to go through the stress of investing out of state, as opposed to near me?  Totally subjective I know, but I guess that's what I need to think about.

    Val, I would have savings right off the bat, and also make enough money from my "day job" to continually have more savings.  I'm also factoring in expenses in my original scenario (which is somewhat realistic), where Total income - Total expenses = 0.

    Would still love to hear what others think.

    0Reply
  • Carlos Powell
    Investor · stockton, CA · Member since 2014 · 34 posts · 3 votes
    9y

    Are you just looking to purchase one house or are you trying to do this with multiple houses over a course of time? It's very risky but possible if your willing to pour your own money in instead of the cash flow. Just remember the rental and housing market just doesn't go up; it fluctuates so just get some more opinions from agents and investors in  The market you wish to invest in and be extremely careful because there's literally no margin for error.

    0Reply
  • Allan Rosso
    Investor · . · Member since 2017 · 173 posts · 84 votes
    9y

    @Chris Ruud I'm going to go off topic here, because you said something that caught my attention. There is no need to eat up the whole $100k you have available to invest, by putting 20-25% down on 1 - 3 houses. Of course it will take more work than simply buying a move in ready home at full value, but there are creative ways to invest, where you wont have to dip so heavily into the funds available to you. 

    For example, my first rental was a bank owned home that had failed to sell at auction and was literally just sitting there. I purchased it for $77K with it needing a new roof, all new appliances, necessary plumbing work (which of course adds the need for drywall work), interior paint, carpet in three rooms, among other things. Even with all the necessary repairs, it appraised for $114k. I got a construction loan, and after everything was said and done, I was about $92K in. Because I had so much equity before I repaired it, I was able to finance the closing costs into the new loan, once I refinanced out of the construction loan. Virtually the only out of pocket expense was the original inspection, as well as lots of little things here and there that I paid for myself, rather than charging to the construction loan. 

    I understand deals like these are not very common, and I feel extremely fortunate to have had it come my way. I was actually thinking I was going to end up having to pay for the closing costs myself, before I knew it could be financed into the mortgage, but I would rather pay 3-6% in closing costs out of pocket, than a 20-25% down payment on a move in ready house.

    2Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    9y

    Your initial plan may be doable although highly stressful when dealing with ongoing unpredictable costs you have no savings to cover. Visualising the reward at the end of 30 years with no ongoing rewards will quickly ware very thin.

    The catch is that when the inevitable blip does happen (lost job, medical expenses, extended vacancy, house fire etc.) you will lose it all.

    0Reply
  • Nick Gray
    Rental Property Investor · Manchester, NH · Member since 2017 · 45 posts · 51 votes
    9y

    Having tenants buy properties for you is always better than sitting on the sidelines, even with a slight negative cash flow. However, think of it this way. How many negative cash flow properties can one afford? As many properties as one's savings from W2 work can subsidize. How many positive cash flow properties can one afford. In theory, infinity. 

    In short, properties with slight negative cash flows can help you build wealth if you're okay working a regular job until they are paid off and if you only want to acquire a small portfolio. But only positive cash flow properties lead to financial freedom and exponential wealth. 

    2Reply
  • Alex J.
    Investor · Tarzana CA and Houston, TX · Member since 2015 · 326 posts · 130 votes
    9y

    I am absolutely against the idea.  You need cash flow.  Put more down or keep looking for a better deal or invest in South la long beach...you need cash flow.  Everything I've done in LA cash flows and I don't buy less than a 6 cap or better..it's very hard to find that right now so I try and do deals where I can "add value" like build a second back house or extend the existing etc or buy and remodel and rent higher etc.  

    I love south la in the non rent controlled areas... 90044 is a zipcode to consider...it's a rougher part of town but still great value and it's neighboring Inglewood.  The numbers still work there as recent as last year I bot a 4plex for 430k that was an 8cap ...I made two of the units into 2 bed 1 bath and now it's a 10cap.

    If you break even or lose banking on appreciation what happens if that never happens? Capex in 30years is certainly going to be required for everyin your property...that will mean at least 100-150k cost in your 30 yr...just my thoughts

    2Reply
  • Chris Ruud
    OP
    Thousand Oaks, CA · Member since 2017 · 11 posts · 5 votes
    9y

    @Carlos Powell Just one most likely, or maybe two houses to hold onto for life.  From everything I'm reading it seems like experienced investors are saying that even during the recession their rents didn't go down much.  I can understand a sudden influx of supply (new construction) causing rental rates to fall, but many of the areas I'm looking in are almost built to capacity.  Are there any other risk factors that would force rents to go down significantly over the long term? 

    @Thomas S. I appreciate what you're saying.  I'm able to save a sizable percentage of my income that would be a cushion in case something came up, and I guess I've always thought worst of the worst case scenario I could quickly sell the property if I could see financial trouble coming.  Plus in a more realistic scenario, rental rates would go up and within a few years I would have cash flow to potentially cover those costs.

    @Alex J.  That's great to hear you've found properties that are cash flowing in LA.  Honestly you're one of the first people I've seen on this forum from LA that is saying that...seems like everyone here just accepts that no cash flow is just a fact of LA.  Are you only talking about MF though?  Or you also get that with SF?  Do you manage those properties yourself?  What is your vacany/maintenance/tenant quality/headache in those lower income areas?  

    I was actually calculating maintenance and capex in my original equation too, but just for the sake of argument let's say there's an additional unexpected 100K capex cost somewhere along the way, and let's also assume there is awful appreciation of only 1%/year, and rents rise only 2%/year, while all of my costs follow inflation at 2%/year (That's pretty bad!) but by my calculations in the end I would still profit over 900K even after the unexpected capex cost, with an IRR of over 7%. I'm not saying that's an amazing investment, but I'm just not seeing where the huge risk is. Even if there was zero appreciation, that would be far far away from financial ruin. I still get cash flow after a few years as rents rise, and especially after paying off the mortgage the cash flow would be considerable. I just wouldn't have cash flow for the first few years.

    I don't grasp how having immediate cash flow vs having to wait a few years for cash flow makes or breaks a long term investment.  I'm not trying to be argumentative here, just trying to understand.  Maybe I'm just illustrating that my investment objectives are different from a more active or fast paced investor?

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  • Hau N.
    CA · Member since 2017 · 153 posts · 74 votes
    9y

    @Chris Ruud I've been debating this exact dilemma your posing.  There are properties that cash flow in where I live (Central Valley) but in class C/D neighborhoods with poor schools and high crime rates.  The SF houses in class A/B neighborhoods just don't have positive cash flow.  They break even when maintenance and cap ex are accounted for (20% total).   I'm leaning more toward investing in homes in excellent school district and hold it until I retire 30 years from now. 

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  • Alex J.
    Investor · Tarzana CA and Houston, TX · Member since 2015 · 326 posts · 130 votes
    9y
    Originally posted by @Chris Ruud:

    @Carlos Powell Just one most likely, or maybe two houses to hold onto for life.  From everything I'm reading it seems like experienced investors are saying that even during the recession their rents didn't go down much.  I can understand a sudden influx of supply (new construction) causing rental rates to fall, but many of the areas I'm looking in are almost built to capacity.  Are there any other risk factors that would force rents to go down significantly over the long term? 

    @Thomas S. I appreciate what you're saying.  I'm able to save a sizable percentage of my income that would be a cushion in case something came up, and I guess I've always thought worst of the worst case scenario I could quickly sell the property if I could see financial trouble coming.  Plus in a more realistic scenario, rental rates would go up and within a few years I would have cash flow to potentially cover those costs.

    @Alex J.  That's great to hear you've found properties that are cash flowing in LA.  Honestly you're one of the first people I've seen on this forum from LA that is saying that...seems like everyone here just accepts that no cash flow is just a fact of LA.  Are you only talking about MF though?  Or you also get that with SF?  Do you manage those properties yourself?  What is your vacany/maintenance/tenant quality/headache in those lower income areas?  

    I was actually calculating maintenance and capex in my original equation too, but just for the sake of argument let's say there's an additional unexpected 100K capex cost somewhere along the way, and let's also assume there is awful appreciation of only 1%/year, and rents rise only 2%/year, while all of my costs follow inflation at 2%/year (That's pretty bad!) but by my calculations in the end I would still profit over 900K even after the unexpected capex cost, with an IRR of over 7%. I'm not saying that's an amazing investment, but I'm just not seeing where the huge risk is. Even if there was zero appreciation, that would be far far away from financial ruin. I still get cash flow after a few years as rents rise, and especially after paying off the mortgage the cash flow would be considerable. I just wouldn't have cash flow for the first few years.

    I don't grasp how having immediate cash flow vs having to wait a few years for cash flow makes or breaks a long term investment.  I'm not trying to be argumentative here, just trying to understand.  Maybe I'm just illustrating that my investment objectives are different from a more active or fast paced investor?

    Both mf and sf...if I can't get the number to work I pass.  I'm also very selective and do only one or two deals a year.

    An example of a deal I did...we bot a house and built a full second house that turned a 6 cap to a 10cap in Canoga Park 91303 area code. We ended up selling it and 1031 exchanging to buy more mf in South la which are generally 6caps. They are "c" neighborhood but it's more like I am investing with the government because of HUD and other programs. In the current environment where there is a lack of yield I'd rather invest there than Midwest or Ohio...etc.. my investment in South la doubled and trippled no diff than the other major parts of LA and has some potential for more upside with the development of Inglewood. That south la 6 cap we added about 80k

    As for the logistics...My father in-law and I work together on all the deals from a to z.  I moved to Houston TX in 2009 but invest almost exclusively in Los Angeles all but one duplex is in Los Angeles.  I handle the deal finding...tenant placing and screening, monthly management of needs and calling vendors etc.  It's not too bad when you get systems in place and also train the tenants from the start.  It also allows me to have better margins.  Having a partner helps for Co managing.   We have maybe one month a year when we have vacancy because we stay very competitive on price any do work that's above average for the area.

    My most recent deal was in June.  I purchased a house in North Hollywood to either develop or make ready for a developer since I have 3 concurrent development/rehabs right now.

    It takes time to find a good deal...a lot of these bp rules won't apply...but I think if it's south la vs Ohio I'll take south la because proximity, familiarity and potential appreciation as a bonus.

    I personally want cash flow exclusively because if it cash flows at 30yr then breaking even on a 15 yr will help me get closer to owning out right an that's when I'll be building real wealth

    0Reply
  • Ryan Evans
    Rental Property Investor · Cleveland, OH · Member since 2016 · 653 posts · 769 votes
    9y

    You're on the right track with the way you're thinking by being conservative, but it sounds like what you're asking is whether you want to have $500k in 30 years, or do you want $750k in 30 years. Now, I think most of us would prefer the latter of the two. 

    Why $750k you ask? Well, $300/month cash flow invested & compounded monthly at 5% over 30 years is $250k. That's my version of being conservative. 

    Why invest in properties that cash flow when you could almost just as easily invest in ones that do. You're leaving money on the table. There are plenty of deals to be had that cash flow $300. The only reason to not cash flow, in my opinion, is if you're counting on appreciation. Nothing wrong with that, but you're doing neither. Sure, it's better than not investing at all, but you'd be leaving money on the table.

    If you're worried about the hassles of going out of state, you're a few clicks away from hundreds of people doing it successfully. The only difference between you and them is a bit of knowledge. And fortunately, you can figure out everything you need to know right here!

    2Reply
  • Jim D.
    Investor · United States · Member since 2015 · 415 posts · 487 votes
    9y

    If you're just doing one or two houses, I don't see a huge risk in having neutral cash flow. But I'd never want to scale bigger than that. 

    My first purchase was cash flow neutral, which seemed fine to me. But then in the first two years I had to spend $6000 on plumbing issues and $4,000 on a new HVAC. After that I bought much more cash flow. The peace of mind knowing you can handle vacancy, big repairs, and down markets is huge. I want to know that if I got sick, couldn't work, etc. that my investments could keep humming along and I wouldn't have to worry about putting cash into them.

    0Reply
  • Jim Schock
    Investor · Jacksonville, FL · Member since 2017 · 27 posts · 13 votes
    9y

    @Chris Ruud I just did some quick math, and have another thought.  The average return on S&P 500 from 1987 through 2016 is just over 10% (see table below).  If you had invested that 100k in  a S&P 500 index fund your total would now be approx 1.7mill.  You would also reduce your overall risk by buying diversified across 500 companies, and have zero holding cost outside of the OER of the index, which is around .003% today.  In your example your investment would lose money even if the value of the property never changed.  The reality is however your property will appreciate at some rate of return.  I would do my homework to see what the long term growth rate is in LA, and even more the growth rate of the area you plan to purchase.  If you don't have that information I would pass on any investment.

    Performance of the S&P 500 Index over various time periodsAverage Annualized Return
    3-Year (2014-2016)8.87%
    5-Year (2012-2016)14.66%
    10-Year (2007-2016)6.95%
    15-Year (2002-2016)6.69%
    20-Year (1997-2016)7.68%
    25-Year (1992-2016)9.15%
    30-Year (1987-2016)10.16%
    35-Year (1982-2016)11.50%
    40-Year (1977-2016)11.07%
    47-Year (1970-2016)10.31%



    Read more: What is the average annual return for the S&P 500? | Investopedia http://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp#ixzz4p0FByO1Q
    Follow us: Investopedia on Facebook

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  • Jim D.
    Investor · United States · Member since 2015 · 415 posts · 487 votes
    9y

    What do you mean by this?

    0Reply
  • Chris Ruud
    OP
    Thousand Oaks, CA · Member since 2017 · 11 posts · 5 votes
    9y

    Everyone's points about possible large capex expenses needed early on are right on, and yes I can see I should start off with a big cushion to not be in danger of not being able to make mortgage payments.  I think I would be tempted to put that cushion (say it was 25K of extra cash) towards a down payment, which actually would raise the cash flow, but I can see the value in being prepared especially with a property that's brand new to you.

    @Ryan Evans That's a good point with the value of even a small monthly cash flow over the course of 30 years.  The idea of investing out of state for my very first investment just doesn't sit well with me for whatever reason.  That's actually why I started this thread.  Even though cash flow might be higher out of state, I was feeling like I'd rather take lower initial cash flow for more comfort.  Just want to make sure it would at least make sense to do very long term. 

    @Jim Schock Yes I was purposely being very pessimistic with my appreciation and rent increase percentages. From what I see, a reasonable historical rate of appreciation is 3% and also about 3% for rent prices. At those calculations I'd actually have almost a 10% IRR after 30 years, which is close to the stock market. The big difference for me is that after I pay off the mortgage I'd essentially be cash flowing at whatever the cap rate is (so probably around 5-6% for a SFR), and correct me if I'm wrong but as far as I know even dividend stocks wouldn't give anywhere near a 5-6% return. I'm mostly thinking of consistent retirement income. Doesn't real estate seem more solid too? Maybe it's just because it's "brick and mortar" but it seems to be less risky than the stock market.

    @Jim D. I think he is saying that if you buy a house for 500K and literally sell for 500K you are losing money because inflation has made that 500K worth a lot less.  And that's totally right, but I think it's safe to say that appreciation will at least match the rate of inflation right?  

    0Reply
  • Jim Schock
    Investor · Jacksonville, FL · Member since 2017 · 27 posts · 13 votes
    9y

    @Chris Ruud So I need to admit I've been trading stocks for over 20 years, and I use real estate to produce a negatively  correlated asset.  I'm not sure I would say that either stocks or real estate are more solid.  To me they are all investments, and real estate is just one other asset class.

    @Jim D. If you invest 500k in a property, and in 30 years it's still worth 500k that 500k has less value due to inflation.  As I stated the reality is it won't stay flat for 30 years which is why it's best to know what the growth rate in your area is.  

    1Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    9y

    @Chris Ruud

    Based on a situation where you would be buying 1 or 2 properties without cash flow I would not consider that to be investing. Without cash flow it is mostly speculating.

    Not much different than buying a personal home.

    0Reply
  • Chris Ruud
    OP
    Thousand Oaks, CA · Member since 2017 · 11 posts · 5 votes
    9y

    @Thomas S. I respect your position but I'm not sure how me conservatively assuming property values and rental rates will at least match the rate of inflation is speculating. I've also given some pretty awful scenarios (appreciation of only 1% etc.) and I still calculate 7% IRR, and calculations based more on history being more like 10% IRR. How can you say 7-10% IRR for 40 years straight (not to mention future cash flow) is not investing?

    0Reply
  • Jim D.
    Investor · United States · Member since 2015 · 415 posts · 487 votes
    9y
    Originally posted by @Jim Schock:

    @Chris Ruud So I need to admit

    @Jim D. If you invest 500k in a property, and in 30 years it's still worth 500k that 500k has less value due to inflation.  As I stated the reality is it won't stay flat for 30 years which is why it's best to know what the growth rate in your area is.  

    I don't think you understand the basic premise here. He's proposing putting a small down payment on a $500k property with a 30 year mortgage, and having the rental income cover the mortgage payments so that it's cash flow neutral after all expenses. If he puts 5% down  ($25,000), and the property value or rents never increase, after 30 years the loan is paid off and he owns the building free and clear. So investing $25,000 and getting $500,000 in year 30. That's a return of 10.5%.

    If the property appreciates even 2% per year (increase of $10,000 on his investment of $25,000), he makes another 40% return because he's leveraged. 

    1Reply
  • Bradley De comarmond
    West Hollywood, CA · Member since 2016 · 235 posts · 72 votes
    9y

    Hey @Chris Ruud

    Welcome! Most investors face that dilemma, especially in California.

    Like you, I live in LA but invest in Florida real estate for the lower prices and cashflow. 

    For me, I want both. Cashflow and appreciation. Cashflow is the insurance policy in case income drops, prices drop, yourself or a family member has a medical emergency and your income gets reduced or you have a break from work.

    Appreciation, to me, is icing on the cake. Cakes taste way better with icing but it's hard to have on its own. (yes I'm hungry and everything comes back to dessert). While appreciation gives you big chunks of money when you sell (if you have the patience and ability to sell at the right time), appreciation without cashflow handcuffs you to that job; that stable paycheck.

    There is no right or wrong answer. If you love your job and feel like you could be there without being fired/laid off etc, appreciation without cashflow is a decent strategy. 

    However, if you're chasing a lifestyle, cashflow is right for you. 

    Hope that helps. Let me know if you want more insight. I work with other LA locals investing in the Tampa Bay/Orlando area.

    0Reply
  • Chris Ruud
    OP
    Thousand Oaks, CA · Member since 2017 · 11 posts · 5 votes
    9y

    @Bradley De comarmond  Thank you for the balanced and informative answer! 

    1Reply
  • Nicolaas W.
    New to Real Estate · Austin, TX · Member since 2013 · 63 posts · 3 votes
    9y

    @Chris Ruud, I am born and raised in the bay area, so I feel you on the real estate prices.
    My father invested in turnkey properties in the Dallas area because CA prices are wild

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