Would You Buy for Cashflow Only?

101 Replies

The area: Sandusky, OH 44870.

The local economy: tied to the seasonal fluctuations of Cedar Point, an amusement park. Most major blue-collar jobs have left leaving a primarily services-based economy around Cedar Point tourists.

Background: I grew up there (live in Maryland now) and have seen my childhood neighborhood get taken over by the Firelands Regional Medical Center and have seen the surrounding area properties fall into disrepair. I have a team in place: agent, prop mgmt company, handyman, lawyer, et al. 

When I buy, I pay cash. I'm fortunate enough to own a couple tech companies that permit me that option. My goal is to find income producing assets for retirement. My two options today are between triple tax-free bond funds from T Rowe Price or incoming producing properties.

I have found a number of cash flowing properties that beat the tax-free return from the bond funds. My CPA created a spreadsheet for me that will calculate the return on these properties by taking into account my current tax rate (the highest) and the tax savings from the depreciation on these properties. When comparing the two returns, I want as close to apples vs apples as possible.

In light of all that, would anyone invest in cash flowing rentals when the potential appreciation is little to non-existent given the goal is cashflow only?

@Terry Dunlap

Hey Terry,

I'm certainly no expert, and others can chime in here, but I think you'll find most REI's invest for cash flow first with appreciation just being icing on the cake since it's never guaranteed. Appreciation certainly builds wealth, but in the midwest, I think you'll find more cash flow and less appreciation.

My two cents, and best of luck!

Yes, but you still have to analyze that deal.  It's all about the deal you make, and how much you are actually paying for the property.

If you're paying all cash, you won't start making a profit until you recover all of it...in your case, from the cash flow.  If you buy a property all cash for $150k, and the cash flow (no loan) is $10k/year, it will take you 15 years (all going perfect) to recover your money spent...and then you start profiting.  Until then, all you're doing is getting your own money back in small (very small) pieces.

If you put 20% down instead, subtracting the mortgage payments, you could be getting $7k/year in cash flow.  That means you would recover all your cash, and start profiting, in year 5.  By the time you start profiting the all cash deal 10 years after), you would have profited $35k already...on just the one house.

Now the fun begins.  Take that same $150k, and put a down payment on 5 houses.  You end up cash flowing $35k/yr, instead of only $10k...spending the same money...and, all 5 houses recover their DP in 4 years.  So, by the time your all cash deal starts making a profit (11 years worth), you would have already profited around $385k.

Can that other investment do that?

Question for you @Joe Villeneuve based your reply: if I secure the homes for cash, and they throw off decent cashflow, I should be able to refi down the road to rinse and repeat the process, yes? One item I see quite often in books: refinancing a SFR held by an LLC is typically difficult. Any experience there you can share?

Or anyone else can share?

If your question is: Would you invest in real estate just for cashflow?  then the answer is absolutely not. It is too much work and you need too many houses.  The real money in real estate is in the capital growth.  That is what will enable you to retire young, debt free and not managing hundreds of houses!

But if your question is: Would you ever buy a cash flowing property in a market that had no growth then yes of course you might, if there was a compelling reason to do so. But you must have both in your portfolio IMHO.

@Terry Dunlap

Terry I don’t have many but my rentals are in the Midwest (Illinois, Indiana).

In a perfect world = have positive Cashflow while you wait for appreciation. If this area is what you described, appreciation maybe a long time coming. So you have to run the numbers (hmmm if I only new a website that has a rental calculator) and see if you can come out ahead.

Also look what @Joe Villenueve said. You can buy cash on a couple or spread your money over many more properties increasing your Cashflow and getting greater return on your money. If you have debt concerns you can use some Cashflow to startin paying off the mortgages. You can leave yourself with multiple options which I think we all want.

Why Sandusky?

It’s extremely seasonal area, everything is pretty much dead in the winter 

There are plenty of other cash flowing towns, even Toledo is better than Sandusky. What kind of cash flow is there? Most inventory is older than 100y.o. - deferred maintenance and CapEx

It’s a money pit .....IMHO

I live by you in Gaithersburg and buy houses for cashflow in Toledo, now up to 6 doors there. I enjoy cashflow since in our area its limited. However I also own appreciation properties in Arlington near HQ2 so I assume my portfolio is decently balanced.

@Terry Dunlap I'm certainly looking at cashflow although I analyze the whole picture when I am looking at deals and appreciation is just a bonus for me!!

Nope..  I cant understand the thought process of going to all the pain of being a landlord with no hope that the asset will go up in value.. you will  WILL lose money with that strategy.. IF IF the assets never go up..  cap ex will eat you alive over time. non payment of rent.. evictions etc etc.. 

Find better markets that might have a smaller return but have a good chance based on logical demand to increase in value. 

Or skip houses all together and go right to mid sized B class MF.. 

$30K cash “investment” with $4800/year gross income is money wasted.

There is no details what’s in expenses but I guess only what you pay out of pocket: taxes, insurance, PM.

90 years old house needs a LOT in CapEx and maintenance/repair reserves. Because there is "long-term" Tenant, you can't really fix everything up front and these miserable "cash flow" will be eaten with first major repair.

This is not a cash flow investment - location is questionable, House is delapidated, $400/mo rent shows the quality of Tenant - I’ve been renting 2bed apartment 13 years ago for $530 - in much better part of Sandusky and still not the best place to live. $400 house will need all the repairs as a normal rental, only you’ll pay for that out of your pocket.

What the point of the investment? $30K in any saving account in a bank will give you much better return - it’s safe and won’t need more money to keep it.

I know @Jay Hinrichs is a wise, seasoned investor.  His advice is well worth reading 3-4 times and pondering carefully.

As for me, I have made a profit for 14 out of 14 years as a cash-flow only investor.  The key is ensuring you are generating SUFFICIENT cash flow to cover all the contingencies Jay mentions.  I use the 2% Rule, meaning the property must rent for at least 2% of the "all in" costs of purchase, closing, rehab, and holding.  My typical rental is a 50-70 year old 2-bed, 1-bath, 700-900 sq foot single family home.  I will pay anywhere from $10,000 to $20,000 and put somewhere around $5,000 - $10,000 in for rehab.  Add $2,000 or so for closing and holding.  My project comes in at a total of $20,000 - $27,000.  Then rent that home for $550 - $600.

Assume 50% of rents are used up by vacancy, capital expense reserves, day to day maintenance, taxes, legal, management, and insurance.  It's a rough and dirty calculation for sure, but I have many years of data on many units to back me up on this being approximately correct.  The $600 unit throws off $300/month net operating income.

A fully financed house ($25,000) at 5.5% on a 15-year note (@$200/month) leaves you with about $100 per month profit.  And that is truly profit because remember we are setting aside funds to deal with vacancy, evictions, busted AC units, roofs, etc.  I have a large reserve fund that has been building over the years, enough to where I could basically rebuild several of my houses from the ground up from nothing and still not eat into my monthly cash flow.  This reserve fund cushion is critically important to maintaining predictable cash flow.

To keep down costs, the cash flow investor must do careful tenant screening.  Even though these are lower-end properties, we keep them safe, clean, and functional, and we demand our tenants do the same.  This means we must be very careful to whom we rent.  There are decent people in the low-income bracket, but of course there are a lot of deadbeats as well.  Keep in mind: one deadbeat can cause thousands in damage to a property, eating up years of profits.  It is better to sit empty than to rent to a deadbeat in this class of rentals (aka Class C).  Collections are a lot harder since they job hop and work for cash.  Nothing to garnish.  Often no bank account to seize.  Credit is often already in the toilet, so there's little incentive to pay you if things go badly.  Zero tolerance for late rents.  Start eviction immediately when they get behind: no delays, no excuses.  

One of the best screening tools we now use is the 2-minute in home inspection.  Assuming they pass all of our criteria, we go to their current home to sign a holding agreement.  If the home stinks, has bugs, or is messy/trashed we simply do not sign the holding agreement and deny the application.  This has been a game-changer as a Class C, cash-flow investor and I highly recommend it.

This kind of investing won't make you wealthy overnight like the big guys who syndicate 200-door complexes in large cities, but it's also something you can do in your spare time and very low risk to see if you like being a land lord.  In the end, it all depends on what you're looking for.

@Erik W.   its a great model for the buy and hold landlord that does it all themselves.. its just a business your business is low end rentals..  you buying a widget to create a return.

the OP is a tech company owner Multiple and is looking for hands off investing.. this type of investing in my mind is a waste of his time and resources.. by the time he farms it all out he would be very lucky to break even.. 

not to mention finding debt on low value assets is a chore in its self.. you can find a local bank that will loan to a local like yourself  but very tough for out of market folks to duplicate this model.. 

and for sure you just play the cards that are dealt you in your market..  were we live in Portlandia and in Vegas there are no 10k homes  hell there are no 10k lots  lots start at 100k  ..  but we also create wealth with move up in values.. 

this is constant topic of discussion..

so IMHO  if your local and you dig being a landlord for 500 to 600 dollar renters.. then that's great . like I said its a small business just like buying any other small business that is going to generate revenue.. I personally don't call It investing though.

Originally posted by @Jay Hinrichs :

Nope..  I cant understand the thought process of going to all the pain of being a landlord with no hope that the asset will go up in value.. you will  WILL lose money with that strategy.. IF IF the assets never go up..  cap ex will eat you alive over time. non payment of rent.. evictions etc etc.. 

Find better markets that might have a smaller return but have a good chance based on logical demand to increase in value. .. 

Just to clarify: cash flow only investment is ok if you're buying at 70% or below of ARV. This is not the case: 1bed/1bath 646sq.f house for $29.9K is absurd. For the price point it's very - extremely - low ROI. For $30K invested Rent should be at least $800-850.

Besides, this is SFR, which means all the CapEx is on the owner.

I have townhouses in that price range and HOA is $185-197/mo but HOA takes care of exterior, including replacing A/C when broken. This house is a joke, not an investment - I wouldn't buy it if they would offer me few $$ to transfer title into my name - because it's not an asset - it's a huge deferred liability.

I don’t see anything wrong with investing in cash flow without future appreciation - whole Midwest does that. We still can catch some appreciation- forced one, when we buy cheap, improve and rent for 2-3% per month of the final price. When it’s a good time to sell - then I’ll make few $$ on appreciation, 25-30% every year cash on cash return (after expenses) and can buy better quality house with deferred taxes (1031).

In this case, it’s nothing above. Someone is unloading inventory in hope that OOS investors will admire numbers on the paper. You have to see the house, walk the neiborhood on Friday night and imagine what kind of Tenants you’ll get for that price.

This is not a stock market, this is REAL estate: every house is different.......”money don’t have eyes”(proverb) - you have to look after your money

@Jay Hinrichs , I 100% agree with you that this type of investing/small business running is more for someone who wants to get down in the weeds, at first at least.

I may not have been clear, but I include management in my list of expenses.  So I "pay" myself a 10% management fee as part of the 50% of rent that goes to Operating Expenses.  Then my $100/month profit comes on top of that.  So one could farm out the management, although I doubt I'd trust a management company.  More than likely, I would train a part-time helper to do all the piddly tasks for me and I'd stick with nothing more than signing leases and do the "Broker only" stuff that my state requires a license for to PM someone elses' property.

So, yes, the OP will probably not want that, already having to deal with two tech companies. But my ending recommendation was to "try it out" to see if being an REI is something he wants to do or not. I have found in my market at least that one invests for cash flow or appreciation, but usually not both. So since he asked about investing for cash flow only, this is the only way I know to make it work in my market. Maybe there are other ways beyond my experience.

Originally posted by @Jay Hinrichs :

so IMHO  if your local and you dig being a landlord for 500 to 600 dollar renters.. then that's great . like I said its a small business just like buying any other small business that is going to generate revenue.. I personally don't call It investing though.

This is the part that I think should be highlighted. I believe it is investing, but as you said it is investing in a small business. Owning rental property that you manage is a business in my opinion. It might not be as intensive as many small businesses, which is what I think makes it attractive (as @Erik W. said it can be done in spare time) but it's not truly passive unless you do nothing but own the product. I think this is where a lot of people get in trouble because they think they'll buy a few houses and never think about it again, just collect the checks. This is difficult to do with a product like real estate because it has to be constantly and consistently managed in order to produce a profit; your success or failure in this area will be directly correlated to the effort you put forth in properly managing the asset. 

I think we (collectively, BP and otherwise) really need to re-frame the conversation about "passive" income. Very little in real estate is truly passive, whatever your interest. I wouldn't necessarily say it's a job in the traditional W-2 sense, but it's also not like when I pull up my Vanguard and see how much I've made (or lost). It's also one of the few investments you can directly influence the value & profitability of through your actions, which in my mind makes it a lot more like a business. 

Originally posted by @JD Martin :
Originally posted by @Jay Hinrichs:

so IMHO  if your local and you dig being a landlord for 500 to 600 dollar renters.. then that's great . like I said its a small business just like buying any other small business that is going to generate revenue.. I personally don't call It investing though.

This is the part that I think should be highlighted. I believe it is investing, but as you said it is investing in a small business. Owning rental property that you manage is a business in my opinion. It might not be as intensive as many small businesses, which is what I think makes it attractive (as @Erik W. said it can be done in spare time) but it's not truly passive unless you do nothing but own the product. I think this is where a lot of people get in trouble because they think they'll buy a few houses and never think about it again, just collect the checks. This is difficult to do with a product like real estate because it has to be constantly and consistently managed in order to produce a profit; your success or failure in this area will be directly correlated to the effort you put forth in properly managing the asset. 

I think we (collectively, BP and otherwise) really need to re-frame the conversation about "passive" income. Very little in real estate is truly passive, whatever your interest. I wouldn't necessarily say it's a job in the traditional W-2 sense, but it's also not like when I pull up my Vanguard and see how much I've made (or lost). It's also one of the few investments you can directly influence the value & profitability of through your actions, which in my mind makes it a lot more like a business. 

Totally agree I am not sure who coined  " passive income or investing" as it relates to being a landlord.. its anything but when your dealing with C class etc.

its one reason in the mid west this inventory cycles so drastically.. 50% of the new inventory comes from burnt out landlords.. I know for a fact in my funding of these things I see it on the settlement statements.. 

At least as it relates to owner operator..  Keep in mind most of what is talked about on BP with regards to these assets is blue sky.. 

we get the occasional Hey it did not work or I have a nightmare tenant or whatever.. but folks that decide they don't like the business they simply don't post..  

So to that end its a very biased and skewed view point when people come to BP with their dreams of being financially free and quitting the J O B and creating 10k a month in passive income in short amount of time.

It certainly can be done.. but its much harder than just buying a few SFR rentals in the mid west and sit back and rain money. LOL>

@Jay Hinrichs ,  heh, no disagreement from me that Class C has some challenges that higher Class properties don't.  However, again I think it comes down to managing proactively.  Get the GOOD Class C tenants and provide homes that are clean, safe, and functional goes a long way toward making them less stressful and more profitable.  Rather than trying to teach a pig to fly, I prefer not to rent to pigs.

Back when I started this biz in 2005, I made many mistakes.  I learned from them and grew past the frustrated, burnt-out LL stage to the nicely profitable and relatively low-impact stage.  Based on my activity log that I maintain for purposes of claiming the QBI tax deduction, I spent slightly less than 4 hours per week of my own time last year managing my business.  Side-bar....Thankfully, the QBI rules say I can also count my contractor's hours, so I should have no problem achieving the 250 de minimus safe habor for 2019.

4 hours per week is not particularly stressful, but I agree it is not--as many have pointed out-- truly "passive" investing.  One might also note that to successfully invest in other "passive" income like multi-fam, syndication, or stock market, there is still some level of effort for the passive investor: attending investor meetings, scouting deals, managing the managers, arranging financing, monitoring monthly cash-flow and market reports, etc.  While that doesn't qualify according to the IRS definition of active income, it certainly is activity that requires time and mental energy.

I'd guess one of the most truly passive forms of income is a high-dividend yield stock or bond mutual fund.  Buy shares; receive monthly or quarterly dividend checks; hang on to the fund(s) forever. 

So I don't get too far beyond the intention of the original post, I'll close out by saying, "Yes, I absolutely would consider buying for nothing but cash flow, as long as the return justifies the expenditure of cash and effort."

@Terry Dunlap this is pretty cool, Terry. Would you mind sending me the spreadsheet (template only) if I gave you my email? I’m looking to build one myself, but I’d like to see what a licensed CPA out together. Thanks in advance!

Originally posted by @Jay Hinrichs :

Nope..  I cant understand the thought process of going to all the pain of being a landlord

Property management does the work, I collect checks, no pain here just smiles.