Why is cash flow important to many here?

62 Replies

Originally posted by @Cara Lonsdale :

So when do you intend to sell propert # 2?  What if you are at the point of retirement, and need to cash out to get that equity, and it is 2008.....and now your property is NOT worth $905K, but rather $290K, and you are at a loss.

THEN what if NOT ONLY do you have no cash flow, but now it is NEGATIVE, because not only the RE sales market tanked, but also the rental market tanked, and you are paying OUT $1,250 per month just to hold on to the property that isn't worth the money you paid for it years ago?

Cash flow is important for many reasons.  However, it's required in order to bridge the gap between market waves.  When appreciation becomes depreciation, cash flow is what will get you through to make sure that your decision to sell is based on a favorable choice, not a requirement.

A smart investor will buy and sell in any market condition, but will shift to accommodate that condition.

I know it is easy to put pen and paper to calculate a perfect scenario.  However, there are alot of unknowns out there that make your calculations irrelevant.  I am a Realtor (since 1997) and a seasoned investor (since 2002) with a portfolio of properties, and I would take that $100K property over the other every day and twice on Sundays.

BTW, the"what if" example I gave you above....true story.  It happened.

 I'm trying to isolate a few variables here, not throw some more on the pile.

But it its 2008, the stock market cratered even more than the average house price, so what if all that money you made from investing your cashflow for House 1, 640k, is suddenly cut in half, but my home value has only declined 40%?  What if there is a plague and half of everyone dies, how does this effect home prices and rents?  What if we get into another housing bubble and I sell all my homes at the peak for millions and y'all are collecting 1k "cash flow"? What if...  We could play this game all day.  I chose a 2% conservative appreciation because that is what I expect inflation to average and house prices have tracked that over the long run.  It could change!  If we are in a recession the exact year I want to retire, I will go on SS, go live in a shack and wait it out.  We're talking about 3 decades from now.

Rent prices did not decline much in the last recession in most cities, if at all, I checked FRED.  I can't imagine we'll have a worse fall from prices right now than we did back then.  If we fall from higher rents, well, then my cash flow will be reduced just like everyone elses.  A lot of people lost during the downturn, even "cash flow" investors. A lot of it had to do with what city you were lucky/unlucky enough to buy in and other things beyond your control.  I get that nothing is guaranteed.

Originally posted by @Jason D. :
@Stuart M. it's all about what your goals are. My goal is to retire in 5 years or less, and to achieve that goal, I need to acquire cash producing properties. If my goal were to increase my net worth and retire at 60, property 2 may be a better play. I live in the Philly suburbs, where property taxes kill cash flow to the tune of $500-$1000 per month, so I have decided to, coincidently, move my family to Florida, because I can better attain my goals. These are all things that you need to consider when figuring out your plan. Personally, I've decided to keep my plan and change my location, rather than keep my location and change my plan.

 Wow, where to?

I moved from PGH to MIA.

But in any case, we love it down here and we couldn't change locations if we wanted anyways, so that works out.  But South Florida home prices...yikes.  It's hard enough to find House 2 down here, House 1 is a leprechaun...and if caught, someone has already written a cash check for it, you have no time for financing and any of that nonsense.

BTW, my PGH RE taxes were much lower than MIA RE taxes due to no income tax down here.  Like a comparable house in a comparable neighborhood is not only 2x as expensive but 2x the taxes!  Total tax burden was the roughly the same.

@Stuart M. we're moving to the Tampa bay area. I lived there in my late 20s through early 30s and loved the area. No income tax is a big draw (3% in Pa) and property taxes are 20% of what they are here.
Originally posted by @Stuart M. :
Originally posted by @Cara Lonsdale:

So when do you intend to sell propert # 2?  What if you are at the point of retirement, and need to cash out to get that equity, and it is 2008.....and now your property is NOT worth $905K, but rather $290K, and you are at a loss.

THEN what if NOT ONLY do you have no cash flow, but now it is NEGATIVE, because not only the RE sales market tanked, but also the rental market tanked, and you are paying OUT $1,250 per month just to hold on to the property that isn't worth the money you paid for it years ago?

Cash flow is important for many reasons.  However, it's required in order to bridge the gap between market waves.  When appreciation becomes depreciation, cash flow is what will get you through to make sure that your decision to sell is based on a favorable choice, not a requirement.

A smart investor will buy and sell in any market condition, but will shift to accommodate that condition.

I know it is easy to put pen and paper to calculate a perfect scenario.  However, there are alot of unknowns out there that make your calculations irrelevant.  I am a Realtor (since 1997) and a seasoned investor (since 2002) with a portfolio of properties, and I would take that $100K property over the other every day and twice on Sundays.

BTW, the"what if" example I gave you above....true story.  It happened.

 I'm trying to isolate a few variables here, not throw some more on the pile.

But it its 2008, the stock market cratered even more than the average house price, so what if all that money you made from investing your cashflow for House 1, 640k, is suddenly cut in half, but my home value has only declined 40%?  What if there is a plague and half of everyone dies, how does this effect home prices and rents?  What if we get into another housing bubble and I sell all my homes at the peak for millions and y'all are collecting 1k "cash flow"? What if...  We could play this game all day.  I chose a 2% conservative appreciation because that is what I expect inflation to average and house prices have tracked that over the long run.  It could change!  If we are in a recession the exact year I want to retire, I will go on SS, go live in a shack and wait it out.  We're talking about 3 decades from now.

Rent prices did not decline much in the last recession in most cities, if at all, I checked FRED.  I can't imagine we'll have a worse fall from prices right now than we did back then.  If we fall from higher rents, well, then my cash flow will be reduced just like everyone elses.  A lot of people lost during the downturn, even "cash flow" investors. A lot of it had to do with what city you were lucky/unlucky enough to buy in and other things beyond your control.  I get that nothing is guaranteed.

 I did not give you a "What if" scenario.  I gave you a REAL LIFE example of what can (and did) happen to show you that speculating doesn't produce the results that you are looking for because the variable you cannot count on is time. 

And your FRED figures take an average, but I can tell you with experience that I went from a rental property at $3,200 rental rate to $1,850, because that is all the rental market would bare at the time (there's that word again).

THe idea of selling at the top is GREAT if we all had crystal balls and could predict when that would be.  At the time (again, that pesky word), I purchased a property for $475K and had to fight to get it.  At the closing table, the property was easliy worth $25K more than I paid for it, and it was increasing with each new listing and closed sale within the area.  There was no end in sight that the same property would be worth $290K just a couple of years later, and when it declined, it declined RAPIDLY.  There was very little warning.  So, when was my opportunity to sell at the top as you suggest?  What was the indicator that the top was here?  This is where speculation and reality coolide.

I really do wish you the best.  I know it is easy to feel like people are discouraging you from what you think is the best course of action.  However, by not considering the vast experience of others as a warning sign to your flawed, untested thinking, you put yourself at risk of being a foolish investor, and repeating the mistakes that many (including myself) have made throughout the course of their investment experience.

My suggestion would be to put your money where your mouth is and let's reconvene this conversation in 5-10 years.

Originally posted by @Stuart M. :
Originally posted by @Eric James:

The correct comparison isn't 5 houses at $120,000 with positive cash flow vs. 1 house at $600,000 with no (or negative) cash flow. In the case of 5 positive cash flow houses you also need to include all the future properties the positive cash flow will allow you to purchase and gain additional cash flow etc.

 Yes, that is a consideration I should take into account.  But just like one assumes access to more upfront funds, the other assumes access to certain inventories that may not exist.  I actually think either one could be a winner, but both have to be found and acquired.  I would personally take either right now.  This whole discussion was to see if there was something big that I totally left out.

Really? You might easily be able to borrow enough to buy 1x $500k house, but might not be able to find 5x $100k homes if you prefer cash flow instead? [I believe you just lost your argument!] Happy New Year...

@Michaela G.

Everyone should be criticizing Strategies in general. It what makes different strategies a learning tool.

I invest in one of the most expensive Cities in the World. It's a different strategy than what is normally posted.

Certain points that I am making is that Cash Flow isn't dependent on the Investment, it's dependent on the INVESTOR.

Just to refresh new readers of this post who skipped through my earlier ones....

Scenario A: An Investment Property sells for $100k and cash flows for $700 per month without a Mortgage. The Cash on Cash Return is ($700 x 12 month) / $100k invested = 8.40%.

Scenario B: Same Investment but you used a Mortgage. Let's say you Mortgaged $50k, 30 year fixed at 5% with a payment of $268. So now the cash flow is $700 minus $268 = $432 per month. The Cash on Cash Return is ($432 x 12) / $50k invested = 10.40%

Scenario C: Same Investment but you fully financed the $100k for 10 years at 5% fixed and pay $1,061 for Debt Service. So now the cash flow is $700 minus $1,061 = NEGATIVE $361 per month.

Clearly, this example shows that the cash flow is completely dependent on the INVESTOR, not the INVESTMENT because the Investment remained the same.

Nothing personal with Math, btw.

Just trying to point out that any property can cash flow it just matters on how the Investor finances it.

But I keep on seeing people suggesting that in Stuart's scenario, it's the House 2 that doesn't make sense for investing because it's a negative cash flow.

What I'm saying is that it's not the house 2 that's the problem, it's Stuart's Financing scenario that's making it break even. So if the break even cash flow makes people feel it's a bad investment, then it should be stated that Stuart can turn that lemon into lemonade simply by putting more money down.

In Scenario C: $95,000 financed at 5% for 30 years is $510/month. No one looking for cash flow is going to finance for 10 years.

@Llewelyn A.

Thats all true but even a McDonalds produces a 6-8% return on cash at min. 

Also, NYC is an international market.  20-25 years ago Brooklyn wasn't the hottest RE market in the world. I would bet banks were not offering traditional or prime financing on places you were purchasing in Brooklyn. Lastly, its one thing as you discussed to double your money in 10 years where market trends be predicted, with an extra strategy versus 30 years what this person is suggesting.

The $2M deal in BK you are talking about makes sense because its 3 units for what $9K a month in rent at least. That may be enough to service the debt/taxes etc plus you get rent increases of significance in Year 3+.

@Stuart M.

An asset is only worth what someone is willing to pay. Its bad business to bet on the asset liquidation to realize profit.  Cost structures can change (property tax increases, insurance cost).  Rents can go down, and higher end properties have large price swings for rents and homes in bedroom communities are harder to rent while school is in session. Even worse any future lending done will view the property as a dead asset aka liability. Because your money is tied up, but it produces nothing yearly in terms of cash, so it will hurt you. I have a couple of high value assets lenders like that because its lets them know you have some cushion if something happens, but cash is MUCH more reliable than values.

Simple - Cash flow = control.

While another property may "pencil" better or have a better overall ROI, but not cash flow, that's extremely risky in the event of a market shift. We're in an overall economy of extremely low interest rates and historically high rents (mass generalization, I know). If you're buying into something that has net zero cash flow, what happens if rates rise, rents and/or prices fall, or unexpected expenses come up? You need to have some kind of buffer. Honestly, I'm super concerned when I see people buying things that pencil today with extremely skinny numbers, given all the above factors. The numbers may work now, but not with a change in even any one of the above potential shifts in the economy.

Don't buy just for appreciation or long-term numbers without considering the ability to control that asset until you reach that final outcome.

But, I'm conservative. :)

@Llewelyn A.

I really appreciate all your posts here. I can see how your line of thinking is somewhat counterintuitive or counter-culture to a lot of folks here on BP. I live in the SF Bay Area and I am beginning to really understand what you are getting at by IIR and different approaches to what constitutes a cash flowing investment. 

I struggle with synthesizing my market with all of the advice/opinions I read/listen to on BP. Real Estate investments here in the Bay Area, like NYC, I feel, are incredibly more multi-dimensional than your typical RE investment in most other parts of the country. The exception to the rule in the Bay Area is buying a SFH house that cash flows and for that matter a Multi as well. However, we also see home prices nearly double every 10 years and while you cannot absolutely count on that as gospel the overall trend is upward - and for a buy and hold strategy this is key. There are ways for the average guy to get both an appreciation play and cash flow, with limited money down - it just takes some creativity and patience. However, you must have a significantly deeper understanding of the market in an area like NYC or the SF Bay Area than most other parts of the country to make this work.

Ultimately, ones buying strategy comes down to their end game. I think all Real Estate investing is speculative, some of it is just less speculative than others. 

@Jonathan Pflueger

Thanks for the vote of confidence in my posts! I'm glad I connected with at least 1 person! haha...

It's very true that there are a lot more dimensions to investing in the larger Major Metropolitans like NYC and SF.

Because an Investor cannot get cash flow in year 1, most Investors just don't want buy because they feel it's risky not to have cash flow.

BUT... as in my previous posts works out, Cash Flow is not a characteristics of the Investment, it's a Characteristics of the INVESTOR.

So.. if an Investment doesn't cash flow in Year 1 and you want it to, just put more down!

It seems like a simple concept, but, as you can see, so many people somehow just keep on calling it speculative when in fact, all I am doing is pointing out a myth about Cash Flowing Investments.

Once we get used to that Cash Flow Myth, we can then look at the expensive Metro Investment and see what advantages it has.

The 2 biggest is that it tends to double every 10 years in value AND the rents move up very consistently year by year.

So you can't really do a simple 1st Year Cash Flow analysis. This is where we need to do the 10 year pro-forma projection with an IRR.

I think most people on BP see large priced Investments, say $1 Million and above, and can't afford to buy it alone, therefore, do not feel any calculations that can be used to help evaluate a more complex Investment is not necessary.

The reality is that any Investment can be bought at any price, you just need enough Partners.

If a $1 Million Investment Property will be $2 Million in 10 years for a 100% Return, that's great!

But what if I don't have $1 Million? Let's say I have only $500k. Well... If I have $500k and Bob, my Partner has $500k, then we can buy it. So what is my return? HALF of the 100% because I put in HALF the money? NO!

When Bob and I sell the Investment, it returns $2 Million. So we split the $2 Million, $1 Million for me, $1 Million for Bob. BUT... I also only put in $500k initially. So my $500k returned $1 Million.... which is 100%!! It's the same ROI as the building returned if it was bought by just ONE Investor.

SO.... no matter how expensive the price of an Investment, the ROI on the Investment will be exactly the same for all Partners. This is how the stock market and syndications work.

Once everyone knows that then they shouldn't put up a barrier on the Price of the Investment. What they need to do is realize that the only thing stopping them from buying ANY Investment is the number of Partners.

The problem here is that many people don't know anyone they can trust to be a Partner. WELL..... that's the real problem. That's where I have to question what they have been doing in terms of networking. Why don't they have ethical people in their lives that they can consider partners and if they do, why do they not join you?

This is where they need to have a thorough understanding of the multi-dimensional aspect of the calculations of the more expensive investment. If you can show your ethical partner a 10 year pro-forma projection with an IRR and EXPLAIN IT, that ethical partner will have full confidence in your ability to lead the way!

The weird part is that throughout the years in both SF and NYC, if you held your buy and hold property for the span of 10 years or more, you would have made Returns FAR exceeding any cash flow Investments where there were no appreciation.

Also, if you were continuing to want to live in SF or NYC, buying your Investment Property protects you from being priced out of that Market.

Anyway, I'm glad my posting at least opened your mind to considering other calculations than the 1st year ROI.

@Llewelyn A.

"Cash Flow is not a characteristic of the Investment, it's a Characteristic of the INVESTOR." This is great, I 100% agree. I feel like so many people, members of BP included, have a single definition of what "cash flow" is, and in that way, limit themselves to so many other ways of evaluating investments - specifically in high cost areas. 

Due to your recommendation in a previous forum I bought What Every Real Estate Investor Needs to Know About Cash Flow and have been working my way through it. I will admit, it's been some pretty heavy reading but very enlightening. Thanks for the recommendation. 

@Stuart M. I think you're missing out on the "why" for a lot of people that are here on BP.  A cash-flow of $0 doesn't allow them to get "financial freedom" in terms of replacing their W2 income.  And when you're looking at a 30 year time horizon that's "retirement age" for a lot of people here.  So the real estate investment scenario you've listed out basically gives them a chunk o' money at retirement.  For a lot of people here that might be no better or worse that shoving money into a 401K that grows until they're 65.  

Other than that I think there are many a couple of other things to think about:

1.) Having (positive) cash-flow means that if the market tanks you can go from making $500/month to $0/month if rents decline, vacancy increases, etc.  Until your second scenario you'll end up with negative cash-flow.  That's all well and good if your W2 can support that but in times of economic stress the W2 might be impacted at the same time as the rent has to be lowered.

2.) When you look at mortgage interest and depreciation as a way to offset net income (i.e. cash-flow) you'll be able to do it annually for quite a while with the first property.  If you already have a solid W2 there is something really nice about tax-free income.  Appreciation is wonderful but you have to either take out a mortgage to get it or sell and incur capital gains.  These are horrible options but tax-free cash-flow is nice.

Anyway, just some thoughts.

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