Equity vs. Positive Cash Flow

General Real Estate Investing
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Equity vs. Positive Cash Flow

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Member since 2008 · 44 posts · 0 votes

With all of the media on the housing market today, it is tough for real estate investors to know what to do. If you live in one of the markets that is suffering from a sharp price correction, you might think that the entire housing industry is imploding. The reality is that there are many markets across the country that are experiencing double-digit annual appreciation. Reference the OFHEO.gov Housing Price Index report http://www.ofheo.gov/HPI.asp. Wenatchee, WA appreciated 25.6% over the last year. Provo and Salt Lake City appreciated over 19%. Grand Junction, Ogden, Gulfport, Biloxi, Myrtle Beach, and Boise appreciated around 15% or better. So there is plenty of buy-and-hold investing still going on in this country, you just need to know where to look.

One of the trends in real estate investing that has resurfaced in the last year or two is the idea of buying properties that have positive cash flow. This is where the rental income exceeds monthly expenses. While it is certainly beneficial when an investment property provides revenue, it is important to realize why an investment might be doing this.

For example, you can pretty much make any property cash flow positive if you provide a large enough down payment. The problem with large down payments is that you end up diluting your ROI. One of the greatest benefits with real estate is leverage, and utilizing large down payments is counter to that advantage.

Positive cash flow is not a panacea. Blindly looking for positive cash flow without considering all the other angles of an investment opportunity is just as wrong as looking for rapidly appreciating markets without regard to any other element. What you need to do is analyze all of the different aspects of an investment opportunity before moving forward with it.In doing so, it is critical that you determine where you are going to get your return. It might be cash flow, it might be future appreciation, it might be the equity you get when you buy right, or it might be a combination of the three.

Cash flow is basically a return you get every month. It will be considered income that you will need to report on your annual taxes. You and your accountant will need to address the tax issue, either by writing off losses against it (such as depreciation or related expenses), or you

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  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    19y
    Originally posted by "SeanBrown":
    I buy and sell properties for both myself and clients.

    Sorry Sean about being a pit bull here myself, but so do you actually have long term rentals yourself? If you do, do you manage them or do the books yourself? Are you just a limited partner in a company that owns them?

    I'm just curious because you seem to breeze over factors that someone who does have rentals understands to be very significant expenses. In reference to maintenance and vacancy, I personally factor 20% of gross rent, and I would never recommend to someone to get an interest only loan on a long term rental. I think that mentality is exactly what played into the bubble that has leveled half the US real estate market.

    Originally posted by "SeanBrown":
    Again, I'm saying that there's more to the picture than just looking for cash flow, and really, I think that is what Mike and you are both saying:
    Originally posted by "Ryan Webber":
    I've had properties that have a lot of equity and little cash flow and I've had cash flow properties that have no equity, and frankly I prefer Mike's strategy of having both.

    I do not JUST look for cash flow in properties. My primary exit strategy is actually wholesaling and I also do rehabbing. Both of which have little to do with cash flow and everything to do with equity.

    I was under the impression that the debate was about Equity vs. Cash Flow, and for my personal portfolio my preference is cash flow.

    Equity gives you a J-O-B, but cash flow gives you freedom. Now sometimes you have to work the J-O-B to get the freedom, but I keep my eye on the prize, passive residual income, otherwise known as Cash Flow.

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  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    19y

    Splinter, to address why someone would sell to you for 50% of value, speed and convenience. I can close this week with no contingencies, no repairs, no inspections, no underwriting, no headaches, no hassles. You say yes to my offer and its good as cash in your pocket by the end of the week.

    And its not just pre-foreclosures, its all types of MOTIVATED sellers. Believe it or not, people do get to a place where there are more important things to them than 30% more cash for their house, but you have to be right there smiling when they are ready. Networking and marketing are your two main avenues to be the one that is making them an offer when they just want out.

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  • N/A N/A
    Member since 2008 · 9 posts · 0 votes
    19y

    Just thought I'd chime in on this issue since I currently own both rental propeties that cash flow, and some that don't. I completely understand and see the merit in what MikeOH is saying about buying postive cash flow properties at discount prices. But, as Sean noted, if it was that easy to find EXCEPTIONALLY good deals, that is all that any of us would ever buy. I have found that, for me, purchasing real estate for my portfolio is sort of like building a good equities portfolio...you need to diversify. I have some properties that are strong cash flow generators, but which required a relatively substantial amount of money down to acquire. (10% - 20% down) On the other hand, I have been able through investment models similar to what Sean has described, to obtain substantial equity positions in other properties without outlaying a large amount of cash. For me, the leverage that low down payment options provide is their primary advantage. I am able to leverage myself into several positive equity positions where, for the same amount of cash using traditional methods, I would have been able to acquire less than one third the number of properties or amount of equity.

    Cash flow and equity positions are, in my mind, very similar to tech stocks and strong dividend producing blue chip stocks. A strong stock portfolio might contain a good mixture of blue chips that bring in dividends and tend to be viewed as a more conservative investment vehicle and some tech or bio stocks that are generally viewed as more risky, but which can bring in strong capital gains under the right conditions. Building your real estate portfolio is no different. You might include some more conservative cash flowing rental properties and also sprinkle in a few properties with neutral or slightly negative cash flow in situations where you can obtain those properties with very little money down and secure an immediate equity position. Is it more risky than other options? Sure...but risk is not inherently bad and obtaining large equity postiions in a short period of time can be very beneficial to a well rounded real estate portfolio.

    Obviously MikeOH has found an investment vehicle that works well for him and he does not want to diversify from that scenario. Fine. But there are some of us that do want to mix things up a bit, and I appreciate Sean's discussion of some of the alternatives.

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    19y

    Tamara,

    So, let me see if I get this right. You buy the cash flow (with a big down payment) with some of your rental properties (which mean they are really losing money) and then you offset that with properties that actually lose money. So, your advice to all the new investors on this site is to buy properties that lose money and then buy some more losers but put down enough money to force them to cash flow. Hey that does sound like a great plan. :roll: :roll: :roll:

    Nobody said it was easy (well maybe some of the gurus did). The TRUTH is that it is not easy. The truth also is that the vast majority of newbies fail and the number one reason they fail is lack of cash flow! So, if you think buying negative cash flow properties is a good deal -- have at it!

    Mike

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  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    19y

    There is some logic to buying properties that have little or no cash flow (its hard for me to take it to negative cash flow but okay) or even negative cash flow if you are buying a large equity position and have a strong exit strategy to convert that equity into cash. I personally always want the cash flow potential there to take the risk.

    I have bought several apartment complexes that had negative cash flow because of vacancy and deferred maintenance. Now my exit strategy combined fixing them up and reselling some of them to get some of the equity out and fixing up and holding others for the cash flow. Bottom line being that I bought them with a negative cash flow and with a tremendous amount of equity, but I had a very precise exit strategy in cashing out my equity before the negative cash flow ate my lunch. It worked barely. I made some nice returns when I finally got them all fixed up and finally sold a couple of them, but the time in between was extremely stressful.

    Which is precisely why I enjoy my sound sleeping now. :D

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    19y

    Ryan,

    I agree with you 100%. However, buying to sell; or buying, fixing and holding with positive cash flow are completely different strategies than what Sean/Tamara are hyping. The bottom line is that Sean apparently has properties that he's trying to unload that won't cash flow, so he's trying to convince us that this is somehow a good thing. I'm curious to know if Tamara is simply shilling for Sean (she hasn't answered that yet, but it's odd that 2 new posters suddenly appear and are hyping the same money-losing strategy).

    The entire equity vs. cash flow is a red herring anyway. You and I both know that properties bought at retail will not cash flow unless you buy the cash flow with a big downpayment. So, the reality is that if you buy a property with positive cash flow, you will normally have at least 25% to 30% equity anyway. You normally can't have real cash flow without equity unless you force it with the downpayment.

    Sean's deal was the perfect example of this. He was advertising properties at 80% of market value and negative cash flow. When you consider that he didn't include hardly any of the operating expenses in his cash flow calculation, theses properties were still priced well above a level that would allow positive cash flow!

    Mike

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  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    19y
    Originally posted by "TamaraBostrom":
    . . . where you can obtain those properties with very little money down and secure an immediate equity position.

    What kind of equity position are you talking about? Are you talking about a 20% discount for negative cash flow or are you talking about a 50% discount? And is the equity built with current accurate comps or is it speculated on appreciation or worse on an appraisal? :shock:

    I guess I'm not understanding the argument. Why would you hold the property long term if it has equity and has a negative cash flow? Why not sell it immediately? If it has a negative cash flow and built in equity wouldn't the best business decision be to liquidate it quickly to maximize the profit? A property with a negative cash flow that has a strong amount of equity is not a long term investment. Your profit decreases every month you hold it. Its a short term investment or you are going to end up bankrupt with a lot of assets for your creditors to sell. :D

    The only viable way I see to the strategy of holding an equity position long term with negative cash flow is to play the appreciation game, which we all know from recent evidence is a very dangerous speculation.

    Other than playing the odds of appreciation, why hold a losing investment?

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