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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  • Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    11y
    Originally posted by @Aaron Mazzrillo:

    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.

     May be a silly question, but how is that $28k refund check considered nontaxable?

  • Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
    11y
    Originally posted by @Andrey Y.:
    Originally posted by @Aaron Mazzrillo:

    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.

     May be a silly question, but how is that $28k refund check considered nontaxable?

    Its not that its tax free, its tax deferred because the proceeds received are secured by the asset (property) and until this asset is sold at a gain there will be no tax ....at the moment. Not tax advice, am not an accountant. 

  • Investor · Detroit, MI · Member since 2014 · 755 posts · 462 votes
    11y
    Originally posted by @Jay Hinrichs:

    @Richard Dunlop

    had not thought of returning to Detroit but your probably right, we did very well there before the epic melt down and got out before that happened. I really liked the little sfr bungalows... before I ventured back I would only do it though with those that are total experts in the market place... in the day when I lent in Detroit I was doing the HML with rate and term refi exit... I would not be comfortable with that model in that market yet.

    But to local players I would revisit it again.. PM me and let me know exactly what your doing

     I'll do that. Thanks.

    Richard

  • Lebanon, NH · Member since 2012 · 258 posts · 87 votes
    11y

    I think we can all thank the sugar daddies and sugar mommies at the Fed for much of the appreciation since the crash in 2008.  The Fed manipulating rates and artificially keeping rates low has probably had a lot to do with propping up the real estate market.  We had NEVER had 3% 30 yr fixed rates in the 239 year history of the United States until recently.    If the free market and not the Fed were dictating rates and they were in the 6-7% range where they should be do you really think we would have seen all this appreciation since the crash?  Some also say the Fed has also propped up the stock market with low rates and QE.  And the booming Nasdaq since 2009 has a LOT to do with all the appreciation especially in places like the Bay Area, Seattle, etc...  I bought rentals post crash 2009-2012 in San Diego and benefited from the sugar daddies at the Fed.  When I bought these rentals I thought they would be long term rental holds that would slowly appreciate, I had no idea they would near double in price in 18 mos from 2012 to late summer 2013.  So I look at making that money as pure luck for me.

    It seems the sugar daddies can keep rates low forever, so maybe the party will keep going on.  But don't think for a second the appreciation $$$ you made in Cali since the crash had anything to do with your skill, send a thank you card to Santa Claus at the Federal Reserve. 

  • Real Estate Broker · Seattle, WA · Member since 2014 · 1k+ posts · 427 votes
    11y
    Originally posted by @Amit M.:

    good quality discussions here on appreciation and cash flow. Nice to hear the varied success stories.  For me, the driver is appreciation and equity gain, but I also balance cash flow for the day to day, as I don't have a w2 job and live off the RE assets. 

    When I first started to leverage and invest, in 2003, the market dynamics were a lot different in my market, San Francisco.  Then it was harder to cash flow because prices were pretty high, interest rates were higher, and rents were a lot lower.  so then my goal was to buy, add value via development/expansion/property repositioning, and then plan to break even with the new rents. I was also more willing to take on developments that needed difficult to obtain city entitlements, so carrying the project became a major cash drain. In 2008-9, that became an issue on a project, and I had to scramble to save the deal, so I can get the cash flow going.  It was a tough two years, but you really learn a lot during difficult times!

    So forward to 2013, when I was finally able to refi and pull out the massive equity that I previously could not access.  In this market it is much easier to get cash flow, even in San Fran.  The hoods I'm investing in are still lower than 2008 highs, interest rates are super low, and the rents have sky rocketed.  I still only buy projects were I can add significant development or property repositioning, as the large pops in equity are my key drivers.  BUT, I can also get near term cashflow now as well. And, I learned from the last cycle to focus on faster developments, so I can close the loop between cash negative to positive faster.  So one project has a 1 year cycle to positive cash flow, with significant rehab work.  And incredibly, I recently purchased a newer construction building, where there will be little physical development; it will be mostly work with the city to reposition use, and also to legalize another unit.  This one makes me cash flow in 2-3 months!  And while overall it will have a tad less equity upside than the other project, it has such low risk, and I locked in a great low fixed rate, that I'd actually prefer doing this type of deal again!  It's an uncommon situation that needs several San Fran specific factors to line up to work, but man I'd just love to have lightning strike twice, as this one was so frickin easy!

    I'm now in the midst of refying again, so I can get a new HELOC for potentially another deal, but now the bar is raised, as I'm working on my two current projects and the market is even more expensive. (I'm not too keen on diminishing returns.). Plus I just doubled my amount of tenants, so I'd like to adjust to that to see when I've hit my limit. We can actually fully retire when the two current projects are completed and call it a day. We will own properties in a class A neighborhood and an upcoming class B, so future appreciation will be there, as well as rent growth. Guess I'll have to figure out what to do with myself if I don't get seducted into a 3rd project later this year :)

    But to reiterate the cashflow vs appreciation question, the appreciation was the driving factor in my investment strategy.  And it was obtained by development/property repositioning, as well as external market growth. Cashflow though remains a critical component that must be managed, especially during a downturn...so you don't loose your marbles.

     Great story, thanks for sharing!

  • Engineer · Bel Air, MD · Member since 2009 · 136 posts · 24 votes
    11y

    great read guys. Good information.

  • Dallas, TX · Member since 2015 · 14 posts · 3 votes
    11y

    never confuse a bull market for competence

  • Investor · San Francisco, CA · Member since 2015 · 60 posts · 46 votes
    11y

    and having the financial and mental ability to put your self out there and make purchases when everyone else is crying the sky is falling.  Willingness to take a calculated risk!

  • Investor · Bay Area, CA · Member since 2014 · 207 posts · 190 votes
    11y
    Originally posted by @Andrey Y.:
    Originally posted by @Aaron Mazzrillo:

    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.

     May be a silly question, but how is that $28k refund check considered nontaxable?

    I am guessing his private lender lent him 125K based on a LTV of the property's ARV, not his purchase price. Since Aaron got it way below market, after the seller got paid, he still has money left over from this transaction. Essentially, he got paid 28K buying a house because he borrowed more than he paid, plus cash flow of $1,700 minus his PITI . You don't get tax when you borrow or do a cash out refi, you get more deductions.

    Aaron is preying on his sellers again :) 

  • Bowie, MD · Member since 2014 · 31 posts · 11 votes
    11y

    Interesting arguments made by both sides and it reveals a lot about the inner-workings of the thought processes that different people likely use when evaluating an investment decision. I don't think either method (CF or long-term equity) is wrong. Just different and produce different results. Hell, I think a mixture produces the best all-around scenario for any investor. Why stick to just one or the other if each has their own advantages? A baseball pitcher who can only throw fastballs isn't going to be very effective. Neither is the one who can only throw changeups. The better pitcher throws both.

    Also, for the long-term equity investors, are you taking into account the time value of money? $1 today is worth more than $1 in 10 years and has an affect on your actual % return. The timing of the return on your investment matters.

  • Real Estate Agent · Atlanta, GA · Member since 2015 · 359 posts · 158 votes
    11y

    Shane,

    Congrats on the deal.  I'm from the Bay Area (GO WARRIORS) and understand that area OK.  That is not a cashflow area.  2-3% return is good there but HORRIBLE in most of the country.  But the Bay Area appreciates like most nothing else. 

    Here is another example... a couple years ago, we took over a family member's house in Marin.  If we sold it then, we would have net about 200-225K.  We didn't have a need for the cash so we just held on to it as a rental.  All-in-all the cashflow was negative about $300/month.  We recently sold it and net about 400K. 

    I know each property is different and each deal has to be looked at closely.  But California is a different animal than the rest of the country.  If you want to invest just in there, then I wouldn't have such high hopes in good cash flow numbers.  Good luck to you.

  • Tax CPA · Charlotte, NC · Member since 2014 · 215 posts · 186 votes
    11y

     What happens if you keep the cash flow on the business balance sheet (far away from personal checking) and snowball the left over into more acquisitions? Or is there more to building wealth? (Coming from a buy and hold perspective). @Shane Pearlman Great thoughts!

  • Investor · Chicago, IL · Member since 2015 · 677 posts · 309 votes
    11y

    Its all relative friends. 

    The guy that made a billion dollars selling oranges will say growing and selling oranges is the best thing in the world

    The guy that made a killing selling sugar cane will say sugar is where it's at

    The guys that made Billions in the stock market  will tell you stocks are end game

    The guys that made good with appreciation............. well guess

    The guys  that are doing good with cash flow will tell you that is the best strategy there is

    I just bought a gold mine for $800K with $25 million dollars of gold reserves what should I say then ?

    hehehehehehe:) 

    like I said its all relative, However real estate is a good investment over all for many people all around the country. 

  • Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    11y

    I think with the right quantity of rentals in the right area, even cash flow can make you rich , especially if you have a frugal lifestyle.

    I'm considering moving to Florida and buying 10-20 rentals in the next 6 years or so, paid outright. I should see 120-240K a year depending if I have ten or twenty rentals, and since my lifestyle is frugal, (I still have nice things just no Benz or Rolex) I can live on about 15K a year comfortably. As such I would invest that profit into either more rentals, or index funds, REIT's, bonds, and other businesses. Appreciation is nice, and in my case the Seattle area appreciation will help my goal when I 10-31 exchange out of here and into Florida.

  • San Francisco, CA · Member since 2015 · 786 posts · 717 votes
    11y

    Of course cash flow builds wealth. What a lot of investors need to learn how to calculate correctly is the IRR (Internal Rate of Return) that accounts for both cash flow appreciation.

    Appreciation is calculated in the time value of money calculation use present value and future value.

    Cash-on-cash measure the return from pre-tax cash flow (not net operating income) divided by the initial investment.

    You combine the time value of money and cash flow on a T-Table and get an internal rate of return.

    It's not one or the other. You have to look at both. This calculation is the most important one in real estate investing.

  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
    11y
    Originally posted by @Ryland Taniguchi:

    Of course cash flow builds wealth. What a lot of investors need to learn how to calculate correctly is the IRR (Internal Rate of Return) that accounts for both cash flow appreciation.


    Two good places to start:

    http://www.biggerpockets.com/renewsblog/2010/09/02...

    https://www.biggerpockets.com/forums/48/topics/164...

  • Rental Property Investor · Dallas, TX · Member since 2015 · 243 posts · 70 votes
    11y
    If you are satisfied w/your results, that is what counts. The scale effect of adding MF to my SFR portfolio is my strategy. Let me know if you would like to set a call to discuss potential mutual MF opportunities in Texas. (I live in No. Ca.)
  • Investor · Milford, CT · Member since 2015 · 200 posts · 69 votes
    11y

    Cash flow is king, if your rentals don't have solid cash flow your going to be in trouble the next time the market corrects. The only number that matters in residential rentals is how much you make per door, that's it, the rest is smoke. 

    If you have solid strong cash flow you will be able to weather 2008 like storms, and actually make money on your rentals which is the entire point. Most landlords actually don't make very much money on their rentals.

    Equity is a different animal and will be their, and healthy if your cash flow is healthy.

  • Rental Property Investor · Winslow, ME · Member since 2008 · 826 posts · 281 votes
    10y

    Looks like alot have chimed in. I'm going to throw two cents in without reading any of them. 

    Whether money comes in as cash flow or appreciation is fundamentally irrelevant. If a building rises in value $50,000 in five years and has zero cash flow or cash flows $10,000 per year is the same. People "tend" to do different things with different types of income though. CF is "cash in hand" (and easy to misuse), while appreciation or debt pay down is harder to access (and therefore harder to f*** up!)

    If you put all your cash flow toward debt paydown, you're accumulating wealth just as fast as the guy whose building is increasing in value. I'm sure there's some esoteric math that might prove my explanations to be slight oversimplifications. That's ok. Being mostly right is better than being mostly wrong. Carry on soldier!

  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
    10y
    Originally posted by @Kenneth LaVoie:
    Whether money comes in as cash flow or appreciation is fundamentally irrelevant. If a building rises in value $50,000 in five years and has zero cash flow or cash flows $10,000 per year is the same. People "tend" to do different things with different types of income though. CF is "cash in hand" (and easy to misuse), while appreciation or debt pay down is harder to access (and therefore harder to f*** up!)

    If you put all your cash flow toward debt paydown, you're accumulating wealth just as fast as the guy whose building is increasing in value. I'm sure there's some esoteric math that might prove my explanations to be slight oversimplifications. That's ok. Being mostly right is better than being mostly wrong. Carry on soldier!

    Agreed...with a couple of (relatively nitpicky) caveats:

    - Having cash from cash flow now is *better* than having equity for later (as opposed to the other).  Cash now is more valuable than cash later (time value of money).  If having cash is bad because you'll misuse it, you shouldn't be in this business...  :-)

    - This doesn't take into account tax implications of passive cash flow versus capital gains.  Longer-term equity may be worth more if you're in a high tax bracket and you'll save money by claiming long-term capital gains -- everything will be dependent on your personal/business tax situation...

    -  If you put all your money towards debt paydown, you're essentially earning whatever the interest rate of the loan is on that money.  If you're paying -- for example -- 4.5% on the mortgage, paying down the loan is a worse financial decision than using that money to invest in something that would generate greater than 4.5% returns.  Not to mention the loss of the interest deduction...

    -  Equity growth through appreciation has an extra tax -- selling costs.  You'll lose 6-10% of that equity growth when you sell, which -- all other things being equal -- can make a cash flow situation more lucrative than an appreciation situation.  But again, your overall financial situation will dictate true outcomes...

    In other words, there are a lot of "depends"...and everything will be dependent on:

    *  Your personal financial situation

    *  Your tax situation

    *  The amount of cash flow being discussed

    *  The amount of appreciation being discussed

    *  Your risk profile

    *  Etc...

  • San Diego, CA · Member since 2015 · 136 posts · 62 votes
    10y

    Great debate starter. 

    I wasn't able to read all the posts as there were tons.  Again great topic starter.  

    My arguments are simple:

    1. Your sample size is tiny, ask any quant or statistician and you need a much larger sample.

    2. Apartments have had compressing cap rates for the last 35 years and are at the highest level they have ever been at.  The reason this puts a little fear in my heart is that what happened 35 years ago is institutional investors started buying into apartment complexes directly.  The asset class became institutional.  Investors now more than ever are chasing yield.  If anything changes from an interest rate stand point, with treasuries, or anything else the very tightly compressed cap rates seen in the multifamily sector may become less attractive to institutional investors.  

    3. Your definition of wealth differs from mine. Yours: High ROI, lots of cash, etc. Mine: Having your ideal lifestyle paid for, for life.

    Not knocking you.  I like the thought.  Keep doing deals but I'd suggest grabbing a few books and learn from the past and other great investors. 

  • Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    9y
    Originally posted by @Aaron Mazzrillo:

    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.

    I agree with you, but when you said CA RE I thought your were buying 700K properties that go up 50K+ a year each, etc. Sounds like you're using the BRRRR strategy if not at least in part. Brilliant strategy on the escrow transfer from the lender. That's how the mega wealthy pay almost nothing in taxes. Borrow against their assets...Pay the debt back with devalued dollars. Refinance, repeat...

  • Sausalito, CA · Member since 2017 · 7 posts · 0 votes
    9y

    Thanks, all. It was a good discussion to read for a newbie.

  • New York City, NY · Member since 2017 · 12 posts · 1 vote
    9y

    I use rental income to buy dividend paying stocks, i then use my dividends to buy put options. I´ve spent my career in trading. But yeah, i make the cash flow from the properties, my stocks yield dividends, special dividends, But call and puts can give large results in a short period of time. Securities are liquid and not correlated with real estate. I like this strategy better because being out of state in my market and tax efficient investing, i am find with holding multi family properties 

  • New York City, NY · Member since 2017 · 12 posts · 1 vote
    9y

    I do not do it often, I can also borrow against the securities at 3-4 %. This is typically lower then anywhere I have found elsewhere. I like this because the money is accessible in 1 day, low rate, there is no payment per month unless issued a call, although you obviously pay the loan, if you hit a point where cf is a proble, it is nice to coast a month or two IF NEEDED.

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