Investor · Mableton, GA · Member since 2009 · 1k+ posts · 465 votes
I recently (...like an hour ago :mrgreen: ) went through this thread exploring the old argument between the cash flow guys and the appreciation guys.More specifically MikeOH and Nationwidepi (Mike and will) and off course some others.
I strongly urge all the newbies( and the seasoned ..) out there to go back and read it, aside from the personal back and forth between Mike and Will which wasn't really personal but a clash of philosophies, the thread really put the light on the issue and the various approaches.
My only two cents in this is that, if you can, why not have both. Diversity never hurt any business. I own properties in Texas for appreciation and in Alabama for cash flow and whatever I don't make in cash flow with my Texas investments, is paid by the cash flow properties in Alabama. My margins in Texas are small anyway, but who can cash flow in Austin with 20% down this day...?
Also, I think that eventually, if you buy properties using fix rate loan, they will become cash flow. It make take five, seven or ten years, but they'll come around.
:wink:
One must not acquire income property that loses money. If you're obtaining a commercial building, you'd be hard-pressed to do that anyways given generally tighter lender standards and a minimum DSCR you've got to reach.
But the big thing to note is you can have your cake and eat it too! Why sacrifice appreciation for cash flow? Why not have both? Its absolutely possible!
But never buy a property that is a money black hole with expectations of appreciation. That's just too much undue risk for me, especially if you're doing that in the more undesirable locations in the nation.
I assume that what you really mean, instead of philosophies, is accounting methods.
I am an accountant, and the figures can be made to say what you want them to say, depending upon what method of accounting you use. There are really more than the normal two methods that are normally spoken of.
The best way to merge the two "philosophies" that you speak of is using the cost accounting method. This actually takes into account every single actual expense for any one specific "deal" and applies all expenses incurred by the company equally or proportionally to each current deal.
Most people will miss many expenses when looking at just one deal, but when all the companies expenses are spread out between all the deals that are ongoing you will get a truer picture of the entire cash flow picture. This even includes the expenses that are incurred to look into a potential deal that does not come to fruition and the lost opportunities for income to be made because monies are tied up in "negative cash flow deals".
There is a lot more to it than just these that I have listed, but the 50% rule is over time found to be the best way to prevent extra time being spent on those losing deals and thus having to spread that time expense cost to all the other ventures that you have going.
Basically put, if your total of all deals (positive and negative flow) does not euqal the bottom line increase or decrease in your net worth at the end of the year, then you have unaccounted for expenses and or income.
So, in other words, your properties in Texas are losing money and are sucking the profits from your Alabama properties. What's the point? Why not sell your losers and buy more winners? The point of being in business is to MAKE MONEY!
Unfortunately, that's not true unless your mortgage is only 5, 7, or 10 years. While the rent MAY go up over time, you'd better believe that the expenses ARE going up over time. While expenses (especially taxes, fees, and other government costs) will certainly go up over time; rents may go up, down, or stay the same. So, if you're counting on time to make you profitable, I'd think again. Time won't help you until those mortgages are paid off (or refinanced with a lower rate or principal balance).
And for the "this time it's different" view, why not go into these markets that are down around 50% and buy for appreciation with income carrying the costs?
If you buy a previously $100K home for $50K and rent it out, and over the coming months and years it "recovers" to $75K, you have captured 50% appreciation.
Since rents have not dropped anywhere close to 50%, you are are more likely to cashflow in the mean time.
I know some of you are pursuing variations on this. It is about appreciation and cashflow. Or maybe it's about cashflow and appreciation.
Better yet, if the houses that were previously worth $100K are now worth $50K, do the hard work to find a deal and buy them for $25K. Then, you'll not only have good cash flow, but you'll also have IMMEDIATE EQUITY of $25K, which is in essence an immediate appreciation of 100%!!! That's the way that you make money in the rental business - cash flow and immediate equity. I'll leave the future appreciation to the speculators.
So, in other words, your properties in Texas are losing money and are sucking the profits from your Alabama properties. What's the point? Why not sell your losers and buy more winners? The point of being in business is to MAKE MONEY
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Mike,
You should have started by asking what is my goal in all this. Well, let me tell you. I don't make a living out of my properties. I don't even consider them as supplemental income. My real estate ventures are my retirement plan. I I plan to retire in the next 10-15 years and although I have a wonderful pension plan from the Directors Guild of America, I'd like to have a bigger cushion. I have a very good day job that pays very well which I love doing.
If I take all my properties combined, I'm still in cash flow despite the fact that some of my "real estate income" cover losses in Texas. Remember, my profit margin is quite high since I by those properties for $12K-16K, spend another $5K-$7K on rehab and rent for $600-685 a month.
"Unfortunately, that's not true unless your mortgage is only 5, 7, or 10 years. While the rent MAY go up over time, you'd better believe that the expenses ARE going up over time. While expenses (especially taxes, fees, and other government costs) will certainly go up over time; rents may go up, down, or stay the same. So, if you're counting on time to make you profitable, I'd think again. Time won't help you until those mortgages are paid off (or refinanced with a lower rate or principal balance)."
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Well, even if the value of the property stays the same and only goes up at the rate of inflation, your still contributing to your principal, meaning , your stake in the property is growing and although I agree that it may not be the case with 30 years loan (Not for the first 15 years) it is with 15 years loan.
I doubt that is what he meant by his statement Mike. It is about exit strategies. While the appreciation takes time, once you cash out, the large chunck of profits is obtained all in one shot, rather than the small monthly amounts over the same period of time via cash flow.
Originally posted by MikeOH:
Unfortunately, that's not true unless your mortgage is only 5, 7, or 10 years. While the rent MAY go up over time, you'd better believe that the expenses ARE going up over time.
This makes no sense. When the rents go up ($100 for example), so do the expenses - yes, but applying the 50% rule, you allow for that increase. The increase in rents and expenses ALSO allow for increased cash flow left over! So yes, over time, your cash flow position gets better, as does your equity position from the tenants paying down your mortgage. While you can only get taht "equity" by refinancing or selling, it is still there and thus a profit (or asset).
Originally posted by MikeOH:
Better yet, if the houses that were previously worth $100K are now worth $50K, do the hard work to find a deal and buy them for $25K.
This of course is the safest and best strategy. Not only have youu assured yourself cash flow, you have instant equity and the potential (depending on the area) to get more equity via appreciation.
The bottom line is, if you can get both, why not go for that! You do not ALWAAYS have to sacrafice cash flow for appreciation. You do not ALWAYS have to buy properties that have the $100 per dor per month cash flow either to make a profit. While you need cash flow if your goal is to live off it, you can also profit from buying in the right places at the right times.
Have you done any side-by-side comparisons of your real estate portfolio versus a broad-based low-cost index fund over the same time period? Include the value of your time, of course. I'd be interested in hearing how it stacks up.
My own strategy is to always buy at a discount to market coupled with the 50% rule. This is very difficult, but it can be done.
And since I've already had to lower rents at three units my margin of error has kept me above water (so far).
Have you done any side-by-side comparisons of your real estate portfolio versus a broad-based low-cost index fund over the same time period?
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Mark,
To be honest with you, No. The reason is, Low-cost index fund or any other fund for that matter, are no fun. I don't have involvement in it, I don't make the decision (Fund managers do) and although I assume that the major component of your question is the "bottom line" issue, it is not the only factor in my decision to go into real estate.
I come from a "typical" Jewish family where you had to be a lawyer,a doctor or a CPA to be considered a success. Instead, I followed my heart and went to study film. This is where my heart was and I always believed that doing what you love best will eventually make you successful and so far I was right.
That's why I got into real estate. The combination of loving it (With all the headache involved sometimes) and the potential growth is what prompted me to get involved.
That has certainly been true in the past and to date, but in case you hadn't noticed, the world in changing. The government has spent trillions of dollars we don't have; they're voting to day on a new cap and tax bill that will cost the average family another $3,000+ per year; and that doesn't even consider socialized health care.
I'm not at all convinced that increased taxes won't outpace rent increases in the future.
That has certainly been true in the past and to date, but in case you hadn't noticed, the world in changing. The government has spent trillions of dollars we don't have; they're voting to day on a new cap and tax bill that will cost the average family another $3,000+ per year; and that doesn't even consider socialized health care.
I'm not at all convinced that increased taxes won't outpace rent increases in the future.
Mike
You have changed the subject here. We are talking about pre-tax dollars, not after tax. You have stated several times yourself that the 50% rule and other calculations do not take into consideration taxes.
You have also stated several times that you don't pay taxes, so the fed can raise taxes whatever they want, it should not affect YOU as you have the deductions in your RE biz to offset taxes.
Past, present and the future, no buts about it! With proper structuring and planning, anybody's RE biz can provide the tax shelters necessary to dodge the feds attempt to rape us.
I'm afraid that you're a little out of touch with what's happening in Washington. The new taxes that are being added are not income taxes or other traditional taxes. The government knows that the American public won't stand for any more overt taxes. Take for example, the cap and trade legislation that just passed in the house and will be moving to the Senate. That is a HIDDEN TAX to the consumer. You'll be paying that in the form of higher energy prices and higher prices on anything you buy that is made with or transported via fossil fuel powered machines or vehicles (production machines, trucks, trains, airplanes, etc). Likewise, the VAT that is being proposed is a hidden tax. It taxes everything all the way up and down the line of production. You'll be paying that in higher prices for everything. The same is true for the coming inflation/hyper-inflation. That's another hidden tax. All these "taxes" will hit via our operating expenses, not as an overt income tax.
You're living in fantasyland! With the stroke of a pen, the government could destroy the rental business (and other types of RE Business). Right this minute, The Chosen One is making drastic changes that will make some businesses winners and some losers. The trick to being in business is to understand what is happening and being the first to the door when the government changes the rules. Don't fall in love with Real Estate Investing. It's just one of a million ways to make money. If it becomes less attractive to another business, I'll switch in the blink of an eye!
"If it becomes less attractive to another business, I'll switch in the blink of an eye!"
Exactly. I get killer ROI on real estate....and I'm prepping everything to sell asap. I've got a lead on a bar right next to a casino I'm doing my due diligence on. If it works out to what I've been told, I'd sell my entire RE portfolio in a heartbeat to make the deal happen.
Back to the topic at hand, I do what Mike and Eddie do - get forced equity now. Screw waiting. Big O's been breaking campaign promises left and right and you have to remember - he's a newbie. This is his first executive experience of any type. You don't know what's going to happen day to day in the next 4 years. Getting forced equity now gives you the flexibility to sell cheap if you have to fast. Think it's impossible? Check history. During the progroms in Russia, Jewish residents were given as little as 3 days to sell their properties. While we may not deal with something that dramatic, you never know when you're going to get hit with something like retroactive tax legislation that hits you with a huge tax bill out of nowhere for 4 years retroactive. This is very realistic. There's legislation just like this pending in Indiana's state legislature - and we're traditionally a red state.
If you get hit with something like that - you won't have time to wait for appreciation to pull you out of the hole.
Out of touch on cap and trade legislation or not, it has NOTHING to do with the conversation at hand or this entire thread! We are talking about cash flow and appreciation which has NOTHING to do with taxes. Try getting back on point. Tax and legislation issues are for the off topic forum, not here.
What ever Mike. Again, you choose to run your mouth about something that has nothing to do with this topic just to have something to disagree with me about. It really gets old. :roll:
I recently (...like an hour ago ) went through this thread exploring the old argument between the cash flow guys and the appreciation guys.More specifically MikeOH and Nationwidepi (Mike and will) and off course some others.
Thanks for bringing that thread back to life here Eddie. While some of the unnecessary (at least in my book) back and forth was present, there is quite a bit of valuable info and insight in that thread. Please do keep in mind that while I took the side of the appreciation in that thread (seems I am one of the few who will be the MikeOH adversary) I value cash flow just as much as Mike does. That said, I think there is a time and spot for appreciation plays in real estate. Mike only looks at cash flow and his little market somewhere in OH as that is how his biz works and by what he states, it does for him.
I, on the other hand, do not soley depend on cash flow to feed my family as there are many ways to make money in RE investing (you already know that!).
There is no rule or no law that states that you can not have BOTH cash flow and appreciation in one investment or in one protfolio.
One point that needs to be clear here and bears repeating endlessly is that while appreciation is great, only cash flow allows you to continue buying and growing a portfolio. Appreciation by virtue of it's name doesn't sustain a business - it's just appreciated. Cash flow grows and sustains a business.
To put it in more "earthy" terms that guys can understand (forgive me ladies) - what's more important? The woman that "appreciates" you, or the woman that "sustains" your needs? No matter how "hot" the first one is, if she doesn't fulfill the second role...it's a slow death.
We are talking about cash flow and appreciation which has NOTHING to do with taxes.
I have to vehemently disagree with you Will. Taxes are a constant fixture of every cash flow analysis of every investment property. Taxes are a component of the cash flow of all business, and investing in property is just one more business that relies on cash flow to exist.
Second thought here - taxes are also a fixture of appreciation depending on when and how you decide to put that appreciation to work.... So really they apply to both topics.
Not all taxes are income taxes and not all taxes can be offset by deductions The types of "taxes" and fees that are now being enacted are not income taxes (although more of those are coming also). With it no longer being politically acceptable to directly raise income taxes, The Chosen One and the socialists on both sides of the isle are now creating taxes that will increase your future operating expenses. Cap and Trade; the VAT; and other hidden taxes and fees will increase your operating expenses and decrease your NOI. There is no deduction for the average real estate investor to offset those types of taxes.
The deductions you are speaking of above offset INCOME TAXES, not hidden taxes that increase operating expenses. If you're going to be in this business, it would be to your advantage to understand these issues and how they directly affect the future of your business.
Yes, historically operating expenses have been 45% to 50% of gross rents. If you buy a rental today, that is the case and that is the best information available today. Unfortunately, it doesn't look like that will be the case in the future. The socialists are determined to increase our operating expenses through 'hidden' taxes and lower our standard of living. The result is that the future may not reflect the past.
If you already own rentals, that means that operating expenses will likely increase faster than the rent. If you buy rentals in the future, operating expenses may be higher than 50% from day one. Obviously, we don't know what percentage the operating expenses will be in the future, but you can reasonably assume that operating expenses are going up if the socialists have their way (and they do). As Tim said, that's even more reason to make your money upfront via cash flow and instant equity.
Finally, as the socialists intentionally lower our standard of living, people will have less money to spend on houses. That is not conducive to significant future appreciation. Why speculate when you can have the money NOW?
Now I have two of you who want to argue a point about taxes on a topic based on the simple question of cash flow vs. appreciation. I will be as clear as pssible so that you both understand (as well as everyone else) as I do not intend on arguing a point, my side, or whatever you would like to call it.
Would it be considered a "business" to invest in the stock market? I would say yes, I would assume both of you would too as thousands of people do this as their sole source of income. That said, unless all the stocks they buy pay dividends, they have no "cash flow" as you define it on a monthly basis. They rely on the stock appreciating to sell at a profit. Point is, appreciation (both in RE and my example), can be monetized into cash flow, it is just not on a monthly basis. Just because both Time and MIKE operate a landlording biz and rely on cahs flow to sustain THAT business, does not mean it is the ONLY way to sustain a business.
Tim, I agree with you that taxes are an important part of every business and I never stated here or anywhere else that they are not. What I was pointing out is that in the appreciation vs cash flow thread, taxes were not the subject nor was any changes to the tax code, either INCOME or CAP & TRADE. It was merely a disussion between which was better, cash flow or appreciation. Since taxes affect both sides of that fence, it just makes sense for the simple purpose of the cash flow vs appreciation discussion to not add it to the mix. Of course an investor must calculate taxes but for the purpose of that discussion it is not relevant.
If we wanted to compare taxes, I woudl say the advantage goes to appreciation as capital gains tax is much less than income tax (granted the morons in powere will raise it more), but we as investors can also defer that tax for a period of time, or even forever using the proper strategies available to us.
Mike's last entire post was all about taxes. Whatever. Still has nothing to do with cash flwo vs. appreciation. If taxes get raised and affect operating expenses, then that is what happens but it would affect both your cash flow side and your appreciation side, as operating expenses come out of your bottom line no matter if you are a RE cash flow biz or a RE spec biz - appreciation, or a combination of the two.
If either of you want to discuss taxes and how the socialists of our country will increase them on us and our business, fine, but do so in an appropriate thread. This is only about what all of us investors feel is better, cash flow or appreciation. While it may appear from the original thread that I was on the side of appreciation, it was only for the sake of having a representative for that side as the cash flow side how enough from Mike. I value cashh flow just as much as the next investor! I also implement both in my business as I feel having both is better than one or the other.
Eddie, this is your thread, I felt it was hijacked somewhat and was lead on a tangent of txes, so I have attempted to get us back to cash flow vs appreciation and this post will be my last attempt to do so. It is all up to you to keep it there if they refuse! Good luck. :D
Ok,
I should have made this one comment before as it's pretty much ends the argument. Let me put investing based on cash flow vs. appreciation in another light. Investing based on cash flow has been working consistently since 700 A.D. Investing for appreciation worked from 1999-2007. Go ahead. Invest for appreciation. Knock yourself out.
As I said, Fascinating and powerful arguments.
Jawsette, although I like your idea and analysis, I don't think that comparing multi-family structure can serve the best when it come to Cash flow vs. appreciation. Multi-family would live and die by cash flow. It is a business of cash flow and that's why many of those in California that were sold in the past 6-7 years went belly up because the numbers simply didn't add up.
SFRs on the other hand, are a better comparison since they have a broader maket.
Naturally, appreciation is driven by economic growth, desirable location - weather (California, Nevada, Arizona, Florida) and the price of land which practically derives from the first two. Therefor those places were exposed to speculators and rouge lending practice that drove the prices higher then they should be and consequently to where they are now.
On the other hand, many cities in Texas, although experienced healthy economic growth, did not see inflation and implosion in RE prices mainly because of abundance of land.
On the other hand, many cities in Texas, although experienced healthy economic growth, did not see inflation and implosion in RE prices mainly because of abundance of land.
Well Texas has many of it's own rules on things dealing with banks and real estate that are separate from the rest of the country. I don't know all the differences but I do know that when you put something as common as a Texas homeowner's insurance policy right next to a homeowner's insurance policy from any of the other lower 48 and you'll immediately see the differences.
Aside from that, do you think it may have been a true abundance of land or merely a perceived abundance of land? I seem to be running across a lot of split but undeveloped lots in Lehigh acres down in Florida (I'm sure Jeff can expound on that much better than I can).