Cashflow Doesn't Build Wealth?

Cashflow Doesn't Build Wealth?

Rental Property Investor · Las Palmas de Gran Canaria · Member since 2014 · 220 posts · 256 votes

While cashflow is key to keep the property safely under control, I seem to find that the larger returns for our portfolio to date come from strategic growth of equity. My wife and I are still fairly small in our investing business and I want to ask if the long-term seasoned investors have found the same to be true, especially in the larger multi families, where value is more closely tied.

Example: A Current Deal We Are Wrapping Up:

My partners and I bought a home in Santa Cruz, CA in May 2011 for 389k and remodeled it. After a cash out refi where we had 108k of our investment left in the deal. Rented the pre-tax profits were $6,840 annually. That is a 6.3% return cash on cash, which in our area is basically a freaking miracle of the crash. I was only expecting 2.8% in my original performa. Haven't seen any deals like that since 2012. The property is being sold and closes in 5 days. For the three+ years we owned it, we basically accumulated $22,550 in rental profits.

In those three years, we saw some serious appreciation. You could call me a speculator, but the indicators were there. A strong job market (thank you silicon valley), a major university, over 3 million tourist annually (to a town of 50k residents), major agricultural center, amazing natural resources / extreme sports meca, a world famous brand and limited room for growth. Houses in a good neighborhood were being sold below replacement cost. I'd call that a strategic acquisition with strong potential for growth. Forcing equity through a remodel provided a nice bit of padding.

We are selling the house for the equivalent of 640k. Net proceeds of the sale minus cash invested is 168k. That is 155% return on investment (37% compounded annualized return). 

Even if I had ended up with a 0% cash on cash, I would still be doing a happy dance. I don't see cashflow deals offering anything in the range of that return

I imagine there may be a day when we need to convert our equity into cashflow. At that point, we will probably pivot again. 

So What Do You Think?

Brandon / Josh often seem to call equity investors gamblers on the BP podcast (although they mostly seem to be warning newbies not to buy stupid), but for those of us looking to build wealth, who are willing to do careful homework, learn the markets, do the deal analysis and make careful strategic plays, make sure we are not upside down or outside our fiscal means, my experience to date says investing in strong equity growth markets, perhaps despite their poor cashflows, seems like the strong play.

Alright, bring on the arguments and tell me where I might be right or wrong (especially as we are moving our portfolio into the larger apartment complexes)!

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Investor · Riverside, CA · Member since 2011 · 2k+ posts · 3k+ votes
12y

I have a few dozen houses at any given time. As @Account Closed stated, one pile pays my bills and puts food on the table, the other pile is for horse trading. Your experience is EXACTLY why buying California property makes the most sense to me. People brag about their $300 cash flow from their dumpy *** $60,000 house out east of the Rockies. Really? I bought a few dozen houses back in 2009-2011. I'm now selling some of them off as they go vacant. The last house I recently sold, I paid $81,000 for it 4 years ago and just sold it for $274,900. On top of that phenomenal gain (approx $150K net), I collected $1,550/month rent from the same tenant all 4 years. 

Now, the naysayers be like "Well, that was the bottom of the market. That can't be done now!" 

I just closed on a nice Riverside house out by UCR. Paid $90K for it. My private lender wired $125K to escrow. I got a $28K refund check from escrow. (Read that as nontaxable income.) Property will rent for $1,700 when I'm done fixing it up. 

Have fun on your airplane ride and staying in Motel 8 naysayers.

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  • Los Angeles, CA · Member since 2014 · 36 posts · 12 votes
    12y

    My goal is to build steady cash flow so in five years I can go hands-off and retire. I'm at six MF properties with total monthly $5,500 cash flow after expenses and debt service. That's with 210K invested in downpayments. Cash flow goes to pay off line of credit to lower interest. If equity comes into play, then it is because I access it to buy more properties. Some downpayments were 30%; values have risen. Now I get to refinance and pull out 80% LTV, or 300K, to reinvest and buy more.

    Cashflow builds wealth if you have more cashflow than your cost of living/playing. Equity can contribute to wealth building. Not sure about you, but 30K/month EBITDA sounds fine with me. 

  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    12y
    Originally posted by @Manch Hon:

    I totally get the theory. But want to know if anyone has successfully used this strategy to accumulate significant wealth. There are all those gotchas in real life that one only knows thru practice. 


    I've used the theory...I just haven't followed-through to the conclusion you are asking about.  I've owned these types of properties for several years, just not for decades.  Tenant quality was just fine; there was absolutely no issues with theft/crime (like I said, B/B- areas); capex was no different (in terms of SOW) than for any other property anywhere in the country; etc.

    Had I continued to hold these properties for the next 10/20/30 years, there are no issues that I can foresee that would make the real life results deviate from the math I provided.  While I understand your desire to find someone who was successful with this method, the lack of such person here in this thread is no more or less telling than the lack of someone here who tried this method and failed long-term...I haven't heard anyone claim that they were on this path but it didn't work out.

    Btw, the only reason I didn't continue to hold them was that I didn't want to settle for 20% COC returns... :-)

  • Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
    12y
    Originally posted by @J Scott:

    Btw, the only reason I didn't continue to hold them was that I didn't want to settle for 20% COC returns... :-)

    What COC returns are you willing to settle for?

  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    12y
    Originally posted by @Jon Klaus:
    Originally posted by @J Scott:

    Btw, the only reason I didn't continue to hold them was that I didn't want to settle for 20% COC returns... :-)

    What COC returns are you willing to settle for? : )

     Up until this year, we were seeing 30-35% annual returns on the cash we have in real estate.  This year, that number has dropped a good bit, as we can't find enough deals to keep our money working, so we've had to partner more (which means lower returns).  Part of that is moving to a new location and part is just the market getting tougher.

    Hopefully we'll still be in the 20% range this year, but it could be lower...those passive 20% returns that we sold a couple years ago are looking better and better...  :-)

  • Investor · San Jose, CA · Member since 2012 · 2k+ posts · 3k+ votes
    12y
    Originally posted by @Ben Leybovich:

    I haven't had a job in 3 years - that's cash flow.

    I saw your post and couldn't resist.  I haven't had a job in 5 years - wife is my cash-flow.  LOL!!!  

    I want to share this article with everyone so you know why some of us behave the way we are.  Thank god San Jose is not on the list.  

    http://washington.cbslocal.com/2014/09/04/d-c-rank...

    Ok, you guys can continue with your debate.  

  • Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
    12y
    Originally posted by @Account Closed:
    Originally posted by @Ben Leybovich:

    I haven't had a job in 3 years - that's cash flow.

    I saw your post and couldn't resist.  I haven't had a job in 5 years - wife is my cash-flow.  LOL!!!  

    I want to share this article with everyone so you know why some of us behave the way we are.  Thank god San Jose is not on the list.  

    http://washington.cbslocal.com/2014/09/04/d-c-rank...

    Ok, you guys can continue with your debate.  

     Maybe one or two cash flow markets on that list. 

  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    12y
    Originally posted by @Account Closed:
    Originally posted by @Ben Leybovich:

    I haven't had a job in 3 years - that's cash flow.

    I saw your post and couldn't resist.  I haven't had a job in 5 years - wife is my cash-flow.  LOL!!!  

    I want to share this article with everyone so you know why some of us behave the way we are.  Thank god San Jose is not on the list.  

    http://washington.cbslocal.com/2014/09/04/d-c-rank...

    Ok, you guys can continue with your debate.  

     I have either lived in or spent considerable time in 6 of those 10 markets...go figure...  ;-)

  • Flipper/Rehabber · Rochester, NY · Member since 2014 · 1k+ posts · 1k+ votes
    12y

    @Manch Hon I am not a millionaire.  And you make a good point in asking if anyone has been able to follow through with this buy-and-hold strategy for years and become one.

    However, as @J Scott mentioned, the lack of someone here does not disprove its efficacy.  To turn the tables, has anyone here become a millionaire by buying for appreciation?  And can they show that they are no just a lucky outlier, that they have timed the market again and again?

    There are plenty of lottery millionaires, but that doesn't mean gambling is a good plan for building wealth.

  • Investor · San Jose, CA · Member since 2012 · 2k+ posts · 3k+ votes
    12y
    Originally posted by @Manch Hon:

    So anyone has built >1M net worth in <=4 unit buildings thru drip dropping of rental income? How did you do it and in which markets?

    Manch,

    Not sure how to break this down, but I re-invested all of my rental income back into buying more properties.  I was buying them cheap during the downturn. I was able to refinance and pulled out anywhere between 100% to 135% of my all-in costs after seasoning.  

    I have achieved 3 out of 4 things that Gary Keller mentioned in his The Millionaire Real Estate Investor book.  Those are 1) think a million, 2) buy a million, and 3) have $1M in equity.  The 4th one is receiving $1M annual income from the investments.  Now, that's a tall order.  Not sure how I will get there.  :-)

  • Investor · San Jose, CA · Member since 2012 · 2k+ posts · 3k+ votes
    12y
    Originally posted by @J Scott:

     I have either lived in or spent considerable time in 6 of those 10 markets...go figure...  ;-)

    Do I hear 7?  Going once, going twice, going third and final time.  SOLD!!!  J Scott takes the cake.

  • Investor · Nipomo, CA · Member since 2011 · 227 posts · 76 votes
    12y

    @Manch Hon , Sorry, I am not willing to share my spreadsheet on the internet but it can be done part time in 8-9 years. 

    Set your goal of 1.5 million net wealth you speak about and engineer it backwards and you will see what you would need to accomplish.

    Happy Investing!

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    12y

    @Larry Turowski 

      there are thousands upon thousands of folks that have made million plus in appreciation in the US...

    I look at my circumstances of living in the SF Bay Area and Portland metro for the last 40 years. these are just my personal residences does not include investment properties. And all sales were I made profit it was tax free either I bought up or then the new tax law for 500k exclusion.

    1. first house Milpitas  80k in 75  sold in 77  125  profit 45k  I am a broker so no commish and wife was escrow officer at the time we got free closing.

    2. Lakeport CA bought 110 in 77 sold 85 for 185k for sale by owner net 75k

    3. 1985 bought 684 Encina Grande palo alto 185k  Sold 91 450k  net 215k

    4. 1991 bought Silverado CC Napa valley 440k included country club membership I put 5k down and assumed the loan that was in default ( my best leverage deal ever) Sold 2001 995k net just over 500k  of which the 500k was tax free.

    5. 2001 bought Kelowna Canada for 220k paid cash my first home I paid cash for to live in lived there 9 months Kelowna went nuts sold for 280k paid 25.% Cap gain to Canadian tax. Net 50k

    6. Bought 2001 Tigard ORegon just after 911 etc for 220k  sold on lease option 12 months later for 280kk buyer sold home in Boise and cash me out. no RE fees net 60k but bought up in value so not tax

    7. Bought Beaverton OR.. 2002  700k  sold 2006  1,150,000  ( not because I predicted the down fall my 5 year Interest only was going to raise my payment a bunch so I took the cash) 450k gain tax free.

    8. 2006 moved into a rental I had I bought it court house steps for 140k downtown PDX> Major down size event. Sold in 2011 for 265k  125k net tax free.

    9 2009 moved into a new build in a sub I built 14 homes in ... built it for 250k  sold it last month for 425k  net 165k tax free

    10 Current home  built nice custom home were I hope to live for many years.

    so for nothing more than living in the bay area and Portland OR. and moving about every 4 years. And other than the one condo I bought at foreclosure and the one home I built I have made about 1.685.000 million TAX FREE by just living and breathing and working on the West coast. and I can flat gurantee there are as I say thousands if not hundreds of thousands of west coast folks that have done this well or far better just buying the right homes. And not paying anything more than FMV a the time.

  • Flipper/Rehabber · Rochester, NY · Member since 2014 · 1k+ posts · 1k+ votes
    12y

    @Jay Hinrichs Wow, that a awesome!  But how do I replicate that?  What areas would you recommend a new investor invest in right now?  How long should they hold?  And what sort of appreciation can they expect?

  • Investor · Nipomo, CA · Member since 2011 · 227 posts · 76 votes
    12y

    @Larry Turowski Did you finish your flip yet?

  • Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    12y
    Originally posted by @Larry Turowski:

    @Manch Hon I am not a millionaire.  And you make a good point in asking if anyone has been able to follow through with this buy-and-hold strategy for years and become one.

    However, as @J Scott mentioned, the lack of someone here does not disprove its efficacy.  To turn the tables, has anyone here become a millionaire by buying for appreciation?  And can they show that they are no just a lucky outlier, that they have timed the market again and again?

    There are plenty of lottery millionaires, but that doesn't mean gambling is a good plan for building wealth.

     Just one property bought in 1978 that has generated over $400, 000 in appreciation and almost $600, 000 in profits.  Properties bought in each decade since are on track to do the same.

  • Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
    12y
    Originally posted by @Jay Hinrichs:

    @Larry Turowski 

      there are thousands upon thousands of folks that have made million plus in appreciation in the US...

    I look at my circumstances of living in the SF Bay Area and Portland metro for the last 40 years. these are just my personal residences does not include investment properties. And all sales were I made profit it was tax free either I bought up or then the new tax law for 500k exclusion.

    1. first house Milpitas  80k in 75  sold in 77  125  profit 45k  I am a broker so no commish and wife was escrow officer at the time we got free closing.

    2. Lakeport CA bought 110 in 77 sold 85 for 185k for sale by owner net 75k

    3. 1985 bought 684 Encina Grande palo alto 185k  Sold 91 450k  net 215k

    4. 1991 bought Silverado CC Napa valley 440k included country club membership I put 5k down and assumed the loan that was in default ( my best leverage deal ever) Sold 2001 995k net just over 500k  of which the 500k was tax free.

    5. 2001 bought Kelowna Canada for 220k paid cash my first home I paid cash for to live in lived there 9 months Kelowna went nuts sold for 280k paid 25.% Cap gain to Canadian tax. Net 50k

    6. Bought 2001 Tigard ORegon just after 911 etc for 220k  sold on lease option 12 months later for 280kk buyer sold home in Boise and cash me out. no RE fees net 60k but bought up in value so not tax

    7. Bought Beaverton OR.. 2002  700k  sold 2006  1,150,000  ( not because I predicted the down fall my 5 year Interest only was going to raise my payment a bunch so I took the cash) 450k gain tax free.

    8. 2006 moved into a rental I had I bought it court house steps for 140k downtown PDX> Major down size event. Sold in 2011 for 265k  125k net tax free.

    9 2009 moved into a new build in a sub I built 14 homes in ... built it for 250k  sold it last month for 425k  net 165k tax free

    10 Current home  built nice custom home were I hope to live for many years.

    so for nothing more than living in the bay area and Portland OR. and moving about every 4 years. And other than the one condo I bought at foreclosure and the one home I built I have made about 1.685.000 million TAX FREE by just living and breathing and working on the West coast. and I can flat gurantee there are as I say thousands if not hundreds of thousands of west coast folks that have done this well or far better just buying the right homes. And not paying anything more than FMV a the time.

    Jay this is a phenomenal categorisation of your personal home buying over the years and the power of that tax exemption.

    You don't hear about it as much these days but the "serial home buyer" strategy of building wealth was pretty popular in the 90s to early 2000s (Possibly before that, but that is my frame of reference).  As in where people would buy a house, often getting a good deal and/or being a light fixer that they then did up pretty nice, then live there 2-5 years then turn around and sell for a big tax free profit (locking in the profits from the good buy, the forced appreciation and usually 20-100+% market appreciation), rinse repeat.

  • Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
    12y

    I could see a scenario where as someone buys a rental and puts all the cash flow into the stock market and beats out Calif appreciation. When I look at the high cash flow areas housing prices, it appears most homes are selling for less than they did 10 and 20 years ago. There are exceptions but if you are in a 2% market now the chances are likely that home will never appreciate or has not appreciated one penny in the last 20 years. 

    All over the midwest those homes have lost 50% plus in value in 10/20 yrs. That is a wealth killer when you compare to 7% annual appreciation markets. Those desirable areas seem to double every 10 and with rent increases year in and out. I have yet to see any period where rents went down in Cali even when values went south. I would consider it an investment luxury to be able to "get in" on these low cap areas like SF.

  • Real Estate Broker · Johns Creek, GA · Member since 2009 · 870 posts · 664 votes
    12y
  • Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
    12y
    Originally posted by @Marcus Johnson:

    Ned Carey I am talking about net cash flow income. Isn't that the only type of cash flow that matters? If you own rentals there are expenses and such as taxes, insurance and upkeep. So even if your mortgages are free and clear, if you don't have tenants then your cash flow is negative. Am I right?

    What is the point you are trying to make?  Of course cash flow stops when there is a vacancy.  You should always put in a factor for that when doing your projections but if you factor in 1 month a year and you sit on it for 5 then yeah everything will get out of whack.

    However this is a bit of a straw man argument since the topic is basically cash flow investing vs. appreciation plays.  If you are investing for appreciation then all the things you say are also true but magnified since cash flow there is less/even/negative to start so a vacancy gets you much more negative, even with a free and clear place.

  • Investor · Bay Area, CA · Member since 2014 · 207 posts · 190 votes
    12y

    @Jay Hinrichs 

    Thanks for sharing.  There is some luck involved.  You really dodged the crash on your primary home.  A lot of people got hurt after 2006 in California.

    7. Bought Beaverton OR.. 2002 700k sold 2006 1,150,000 ( not because I predicted the down fall my 5 year Interest only was going to raise my payment a bunch so I took the cash) 450k gain tax free.

  • San Jose, CA · Member since 2011 · 160 posts · 167 votes
    12y

    Next year I should exceed $1M in real estate equity, and I started investing in RE only 3 years ago. You can say I am lucky. And I do think I am lucky. Appreciation has treated me very well. 

    I agree there are people who achieve 1M wealth thru drip dropping rental income. But the fact that J Scott and others chose not to do that means at least there are better ways to accumulate wealth. I know many, many people all around me who seem to easily achieve 1M equity by doing nothing, like Jay, just by living and breathing in Silicon Valley. 

    Are there people getting rich by cash flow alone in flat markets? Of course there are. But I want to see what are the difficulties they face, how easy it is etc etc. 

  • Investor · Arlington, VA · Member since 2012 · 1k+ posts · 491 votes
    12y

    @James Park , love the observation: "Strategically buying and holding into emerging path of progress is how real estate millionaires are made."  You have seen this with real estate moguls in NY, CA, and TX.  These individuals tend to puchase property (usually just land) in paths of expansions (e.g., outside of LA, Houston, Dallas, NYC, etc.).  Then reap the rewards when they are encroached by the city.

    This thread is beginning to change my perspective quite a bit on cash flow vs. appreciation. I still believe that both strategies play a vital part in one's portfolio for, if nothing else, diversification. However, to paint a picture, the two homes that I've purchased at ~.85% market rents in class A neighborhoods have each appreciated dramatically (one at 33% over 6 years, the other @ 10% over 1 year). These homes were purchased with VA loans, using almost none of my own money. So, letting someone else pay down your principle while you wait on appreciation in GREAT markets seems to be a pretty good formula for success. I love the idea of living in a great neighborhood and then moving and rinse/repeating. And the confirmation in this thread in heartening. This coupled with purchasing cash flowing properties elsewhere could be the "key" to success.

    Just my .02 cents

  • J. MartinPro Member
    Rental Property Investor · Oakland, CA · Member since 2011 · 3k+ posts · 2k+ votes
    12y

    I'm trying to follow in @Jay Hinrichs footsteps, but rather than avoiding taxes by doing owner-occupied, I'm going to avoid taxes by never selling them :) They're on 30yr fixed, so even if they don't appreciate, they get paid off, and I'm getting the best of both worlds on cash flow and appreciation in the Bay area.

    Welcome onboard to the appreciation train @Frankie Woods ! Some of us Bay Area folks are drinking the same Kool-Aid on this. @Account Closed , @Amit M. , @Kathryn M. .. @Account Closed drinks some even stronger appreciation koolaid (from Hawaii ;)

    We're also all buying at good discounts to market, and/or big upside through action that can be taken: forced appreciation plays like buying distressed properties, poor condition, tenant/below market rent issues, etc. that give a good amount of built-in equity. So worse comes to worse, there is an exit opportunity.

    Some on BP think we're out here paying a million dollars for crappy little houses, purely with the hope that the prices go up, and we're losing money like crazy in the mean time. Not the case. But they're also not all big cash flow from day one. Many need months, or even years to turn around, depending on the circumstances. But the equity and cash flow upside is usually big, even before market increases. Market increases then provide the huge additional returns that we seek..

  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    12y

    Just a quick recap, since I'm getting a decent number of messages in my inbox about this thread...

    If you go back to earlier posts in this thread (or perhaps it was the other similar thread on this topic), I made it perfectly clear that I believe it's possible to make a lot of money with appreciation.  My stance isn't that it's not possible; my stance is that by putting a significant amount of your net worth in a high-priced market and banking on appreciation is a riskier strategy than diversifying in a lower-priced markets and investing for cash flow.

    Just because it's riskier (in my opinion), doesn't make it wrong.  In fact, as someone who perfectly is comfortable sitting at a poker table with enough money to buy a house, I personally am certainly not risk-averse.  But, many people are, and for them, banking on appreciation in high-priced markets isn't necessarily the right strategy.

    So, before you message me, keep in mind that I've never argued that you can't make money on appreciation...just that it may not be the optimal strategy for many people. 

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    12y

    @Frankie Woods 

      your absolutely correct some of the biggest hits in Real estate are the farmer's who owned their family farm for 20 to 100 years progress envelopes them and the next thing they know they just sold to a developer for who knows how many millions..

    I remember growing up in San Jose  ( Cupertino specific) it was apricots, cherries and farming.. I remember when one of my class mates parents sold there 20 acre apricot orchard for 1 mil.. that was early 70's  unheard of sum...

    The Mariani's in Silicon valley were one of the largest fruit growers and land owners back from the 1920's on.. they methodically sold their properties to developers and moved their fruit operation out to the Central valley.  They made BILLIONS in Santa Clara county path of progress sold the farm to developer deals. 

    So CAl same thing..

    I have my own little path of progress play  I bought 4 acres in Sonoma county ( Rohnert Park) in 1994 for 27k... it was unbuildable at the time but it was right behind a brand new Shopping center anchored by Home Depot.. so I thought if this can come into the city of Rohnert park some day it will be a good land play.. Well dumb luck again it came into the city ( specific plan is being worked on now.)  But the Graton Indian tribe backed by Texas Station Casinos bought the 120 acres across the street for 200 million and built the larges Casino in Northern CA.. they brought all Utls in new road with a light right at my corner. The 200 million was the largest RE transaction in Sonoma county history at the time .. There are probably some timber and Vineyard sales that rival it.

    But bottom line I am now sitting on 4 acres that is going to be zoned multi use commercial Residential so when the day comes we either flip to a developer or I will build out the Commercial on the bottom and condo's on top.. and since I have do debt it should work pretty good.

    Buying path of progress is a play that is usually done by larger companies that can land bank and builders looking for inventory for 10 years from now.. Like larger CA builders since it takes for ever to get through planning.. My little 4 acre's has taken over 10 years to get through the city all the law suits from the opponents of the casino etc etc.

    In the meantime in the spirit of buy low and sell high I have the property listed at 3.5 million if someone makes an offer I will sell... Heck I would probably take 2 mil and call it a day  :)

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