Cashflow: BP most MISUNDERSTOOD term
Investor · USA · Member since 2015 · 325 posts · 447 votes
I read too many posts from investors about "cashflow per door" or "that house does not have a positive cashflow", ect. I feel like the prevailing thought is that it is about "cashflow", singular, when real estate investing is about a series of "cashflows", both positive and negative. I will point to a property I purchased;
Purchase Price: 185,000
Downpayment: 46,250 (Negative)
Monthly Cashflow: 200/month for 5 years (Positive)
Refinance: 75,000 (Positive)
Refinance: 115,000 (Positive)
Monthly Cashflow: -75/month for last year (Negative)
I would say the property is cash flowing great! Over the years I have been able to pull out around $150K to buy other properties, along with some MONTHLY cashflow.
Why focus solely on monthly cashflow? If you do not have appreciation, all the depreciation of the property will eat up the gains when you sell. I would rather invest in something that has a huge payout in 30 years, or 9 for this case study. That is the final cashflow for any asset, when you sell!
@Kai Van Leuven Cash flow is a very well defined term. Let’s not muddy up the misunderstandings further by trying to redefine it.
Cash flow is the the net income (or loss) after all expenses and mortgage (principal and interest) payments.
That is hardly the whole whole picture in investing but it does mean something. Your definition does nothing to clear that matter up. You even use it yourself in the way you day it shouldn’t be used.
It sounds like you want to talk about infernal rate of return (IRR). That does give a fuller picture of investing and cash flow is a component of it. But it is a fairly advanced concept and difficult to formally mathematically define. Most people don't need to define it formally and like you can see the benefit of it in a more free handed way.
I read too many posts from investors about "cashflow per door" or "that house does not have a positive cashflow", ect. I feel like the prevailing thought is that it is about "cashflow", singular, when real estate investing is about a series of "cashflows", both positive and negative. I will point to a property I purchased;
Purchase Price: 185,000
Downpayment: 46,250 (Negative)
Monthly Cashflow: 200/month for 5 years (Positive)
Refinance: 75,000 (Positive)
Refinance: 115,000 (Positive)
Monthly Cashflow: -75/month for last year (Negative)
I would say the property is cash flowing great! Over the years I have been able to pull out around $150K to buy other properties, along with some MONTHLY cashflow.
Why focus solely on monthly cashflow? If you do not have appreciation, all the depreciation of the property will eat up the gains when you sell. I would rather invest in something that has a huge payout in 30 years, or 9 for this case study. That is the final cashflow for any asset, when you sell!
Are you an accountant? You're basically defining what the statement of cash flows would look like in quarterly financials or a form10-K which follows GAAP. I agree that your definition of cash flows is technically correct and is the proper way to report things from a financial reporting persective. But you can't expect folks here to use the term from a GAAP perspective when it appears that most of the cash-flow folks here believe that your primary residence is not an asset but actually a liability (as evidenced by a recent thread on this topic).
@Tony Kim
I am not talking about any of that. I am simply saying that you have to look at the complete cycle of your real estate. From buying, to stablalizing, and then disposition. If you are not focused on those simple stages within your purchasing then there are huge gaps. It all has to do with cash flows... ya know, why anyone really got into the business.
@Mike Dymski
Mike you are a better writer than I am. That is really what I am trying to say. Cash flow is literally money either coming to you or leaving your bank. It is really the most simple way to look at it.
Why this is blowing people’s mind... I am not sure...
I will take the term of "operational profits" that works. I think that the way it is thrown around on here you could also use the term "Fools Cashflow" or "Morris Profits".
There is a ton of logic in taking on debt to finance future projects. If Chase did it they would have the same obligation to the folks holding the paper and I do with a bank that underwrote my loan. They may make it sound fancier by calling it "Corporate Debt" but its the same thing. Not a "House of Cards", just business.
As far as having a negatively cash flowing property... maybe my original post was a little misleading. I could not even tell you how many deals that money has found its way into. I am sure it doing just fine but I don't keep score at this point in my investing ;)
Commercial lenders don't look at just one piece of the puzzle. They usually factor you DSR of the whole thing. You are correct, if your portfolio consists of properties that are all negative, no one will lend to you, no matter your net worth.
I have just tried to "pour gas" on investing over the years. The Seattle market has made me look much smarter than I actually am!
It appears OP is confused about cashflow. They think their negatively geared purchased is cash positive. Life will teach them reality I guess.
@Llewelyn A. This is a great description of the underlying calculation mechanics, but could just use the IRR function in excel to automate all of this. It's the best way to analyze the "true" return on a specific deal. IRR is closely related to the net present value function: basically you have to discount the individual cash in/outflow amounts over the course of the hold period to the present day (given the time value of money).
https://support.office.com/en-us/article/irr-function-64925eaa-9988-495b-b290-3ad0c163c1bc
@Tony Kim
I am not talking about any of that. I am simply saying that you have to look at the complete cycle of your real estate. From buying, to stablalizing, and then disposition. If you are not focused on those simple stages within your purchasing then there are huge gaps. It all has to do with cash flows... ya know, why anyone really got into the business.
Yeah, I'm with you 100%. The vast majority of my properties are in So Cal. I recently 1031'd an SFR here in Los Angeles which I purchased back in 2011 using 70K as a downpayment into a multi-unit property. Per your definition of cash flow (which, not surprisingly, is the definition that I agree with), this property had spectacular cash flow as it nearly tripled in value while only providing me with a modest monthly cash flow before selling.
But the few thousand a month I get in cash flow from this newly acquired multi-unit is not going to make me rich...just like the few hundred a month I made from the SFR wasn't going to get me rich. If my profits were limited to these amounts, it would not be worth owning these properties as I could get better cash flow via online syndications, HML funds, etc while sitting back and doing nothing. As you mention above, the complete cycle of your real estate holdings must be examined.
@Michael Magnell I agree, @Llewelyn A. is picking up what I am laying down but I am not even talking about discounting cashflows for an IRR. I am talking about just cashflow. Like literally money coming in, and money going out. Not assigning a PV for it or anything.
@Michael Magnell I agree, @Llewelyn A. is picking up what I am laying down but I am not even talking about discounting cashflows for an IRR. I am talking about just cashflow. Like literally money coming in, and money going out. Not assigning a PV for it or anything.
W/ all due respect, I think this frankly only works on shorter hold periods - if you start to calculate out a five-ten year hold but don't factor in PV, the #s will look muuuuch different.
That said, I think - conceptually - your explanation is approachable for the vast majority of investors who just consider money in, money out.
@Dean Letfus Actually, I don't think the OP @Kai Van Leuven is confused. I think he's trying to articulate something worth considering. It seems there are different layers that define what cash flow really is, yet we tend to hang on to the static definition as is commonly defined here on BP. I'm offering this from the perspective of a West coast investor who looks at cashflow differently because we must carefully consider appreciation when we invest in a West coast asset. If I recall correctly, someone said that people trip over the cashflow issue if they don't net a positive CF each month and they walk away. But if the definition can be a bit more dynamic regarding all the variables that comprise an investment, maybe those people should reconsider the investment rather than walking away. Finally, the CF definition for a Midwest BRRRR investor and my definition investing in West coast RE that's well north of an $80K SFH for the long term does not use the same approach regarding a very careful well- thought-out potential investment.
Maybe we need people like Kai to challenge the echo chamber responses that are always posted as broken record rebuttal and advice. And, the echo chamber narrative is never buy unless the asset cashflows a minimum of $150 per month as if that's the predominant blip on the radar screen.
Interesting thread regarding IRR:
...infernal rate of return (IRR)...
When the economy turns and an investment goes diabolically wrong, you have an infernal rate of return.
This thread strikes me as essentially "people in different markets with different goals, different financial circumstances, and different experience levels use different strategies than me... therefore they must be wrong!" Most people here don't define cashflow as if they were accountants and they probably don't analyze everything like hedge fund managers. I wonder if that could be because they are not accountants or hedge fund managers? Go to the about section of the website: "our goal here at BiggerPockets is to help ordinary people like you build wealth through real estate."
I realize that BP is open to all levels of success and experience, but the primary goal of BP as frequently stated by the company on their literature, webinars, and in the podcasts, is simplifying real estate investing so that ordinary people who are not rich or formally trained investors can get involved. Ordinary people are going to feel overwhelmed if they start listening to a podcast or join the forums and immediately get hammered with GAAP terminology and complex analytical algorithms. Moreover, most "ordinary people" would have serious problems weathering an economic downturn or financial rough patch without having positive operational cashflow. If the annualized appreciation on your property over 10 years is projected at 5% each year, that looks great on paper, but if the investor loses the property after year 1 due to negative operational cashflow and exhausted reserves following a shift in market conditions it becomes irrelevant information. This is a real concern that ordinary people--BP's target audience--have that experienced investors with a healthy diversified portfolio and significant reserves may not need to worry about as much.
I don't think that using operational cashflow as the core metric on BP is an error or a misunderstanding, I think it is a conscious choice due to it being a simple and safe metric that minimizes the likelihood of newbie investors experiencing overwhelm or major loss early in their investment careers and going back to "watching dancing with the stars".
Thanks for the comment Michael. If you read a LOT of my past posts, I basically go through several scenarios like the above and explain how to build Excel business models with 10 year pro-forma IRR calculations.
One of my best friends invests in the same market as me (Houston). His cash flow was $3.1 MILLION last year after all expenses.
Ask me what his appreciation was? Who knows. Who cares
(actually Houston has been on a rocket ship up so my guess is he made $10m+ on paper. But in terms of money in his account each month, that $250k+/month of pure cash flow is hard to beat)
Originally posted by @Michael Magnell:
I've been trying to model the 15 year returns of a hypothetical negatively cashflowing property using IRR. So I have myself a 180 entry column in which each entry is the sum of mortgage paydown, property appreciation, scheduled depreciation tax benefit, and actual cashflow. This number is positive, though the cashflow starts negative and eventually goes positive due to appreciating rents. For one model of a $500k purchase of 5% appreciation and 3% rent rise I end up with a $-125k downpayment, followed by $2600 in field 1, incrementing up to $7600 in field 180.
Here comes the problem: a straight IRR yields 2.67% per period, or 32% if you calculate it IRRx12. Using XIRR instead as someone recommended to me yields 1.52%, and they said use ((1+XIRR)^12)-1 to arrive at an annual rate of 19.78%. Calculated using gross $243,439 investment to the final $1,053,613 value, disregarding the extended timeframe of the inputs, yields 21%, so 19.78% has more of my confidence at this point.
I can also take my monthly rate of return and average it to come up with 12.48%. I simply have too many different results! Do you have any take on this?
One of my best friends invests in the same market as me (Houston). His cash flow was $3.1 MILLION last year after all expenses.
Ask me what his appreciation was? Who knows. Who cares
(actually Houston has been on a rocket ship up so my guess is he made $10m+ on paper. But in terms of money in his account each month, that $250k+/month of pure cash flow is hard to beat)
That sounds awesome, if he's capitalized at $10m. If he's capitalized at $100m, not as great. This is why just citing raw cashflow numbers are meaningless. I just saw an article calling Houston one of the 4 biggest bubbles in the country.
@Llewelyn A.
I'm not denying the possibility that IRR may in some cases be worth considering, I'm saying that it makes sense for entry level real estate investors who are buying SF or small MF properties (most BP members) to use CoCR as their primary metric in most cases.
Also, I'm not trying to pick a fight here, but I think we both know that your "real world" example is not so real. First of all, it isn't even real estate. A mobile home parked on rented land is personal property, not real estate. Even a fixed mobile home on owned land that has been legally converted to real property still has a depreciation schedule wildly different from the overwhelming majority of real estate situations.
Secondly, you say that CoCR cannot handle any scenario beyond the first year. I concede the point but counter that the IRR cannot handle any scenario prior to the last year. Case in point? You just posted a figure in which the investment went into negative cash flow after the second year and then assumed that the investor just ignored it and held for another 18 years... I realize you were just using that as an example, but it is laughably unrealistic. People on BP buying one house or a duplex or trying house hacks are going to be frequently buying or selling or refinancing. CoCR is a bad metric for comparing a series of big static purchases that are going to be held very long term, but IRR is often a bad metric for a small relatively high-liquidity purchase that may be sold or renovated or refinanced in a matter of years or even months after initial purchase.
Saying that using CoCR instead of IRR is "why only 5% of the Investing Populations will sit on the rich side of the fence and the other 95% will try to climb over" is... let's just leave it as hyperbolic, at best.
Edit: P.S., the BP calculators that are pushed so hard on newbie investors in the podcasts factor in changing income/expenses and appreciation/depreciation and very clearly display returns over time. I seriously doubt anyone literally just sees a positive cashflow and buys without any additional thought to location or the possibility of changes in future revenues, nor have I ever heard any BP contributor or employee suggest such a thing.
...infernal rate of return (IRR)...
Does this mean that as people learn and gain experience that they should not seek to improve themselves by updating their metrics with more useful and powerful calculations?
Because this is a site geared toward the non-finance guru, more advanced conversations should not happen from time to time on the thread which could help us all get better because it may be difficult to understand for a beginner investor? That seems slightly paternalistic and carried to its logical end will mean that this forum will only be used beginners and some simplistic investors who like hearing themselves talk.
I disagree entirely. The majority of people I've seen on the forums think you only make money via operational cash flow and have no idea about the other three wealth generators of REI because they have no investing framework over and above what they have heard on podcasts. Threads like this, while more advanced, help expose the community to ideas and methods of investing beyond Cash Flow is King crowd.
I think the emphasis on cash flow drives a lot of bad behavior. I see all the time people posting "I live in California and nothing here cashflows. I have a bunch of equity in my house that I can refinance but I'm looking out of state so I can get cashflow."
So let me get this straight. You're going to shuffle around assets so that you are taking equity out of an asset that has made you a ton of money for the last few years and sending said money to the middle of nowhere all so you can get a measly $100 a month?
People love the cashflow metric because of its simplicity. But at the end of the day, relying on a simple metrics leads to only having a surface level understanding.
Just to clarify, I called my scenario a "Rental Investment."
I don't want to get technical, but even Coops are not "Real Estate" since they are corporations.
Coops don't even pay a Mortgage Recording Tax (at least in the past) because the MRT was a tax on Real Property and Coops were not considered that for Tax purposes.
The Negative Cash Flow example is REAL and happened occasionally to properties in my portfolio.
For NYC and many other highly appreciating places, CoCR will keep you out of those tremendous markets. Markets which would make you really wealthy.
But the IRR will help you evaluate in ANY Market.
If I were to calculate the percentage of people in my circle of friends and family that DID NOT invest with me in the 21 years I have been investing in NYC, it reaches the same statistics, 95% did not invest. One Relative and One friend did in the beginning.
The 95% of my friends and family considered it a big risk solely based on lack of cash flow and ignored the IRR or just really didn't understand it.
Now, almost ALL of them are priced out of the NYC Market.
That is NOT hyperbole, that is just FACT.
One of my best friends invests in the same market as me (Houston). His cash flow was $3.1 MILLION last year after all expenses.
Ask me what his appreciation was? Who knows. Who cares
(actually Houston has been on a rocket ship up so my guess is he made $10m+ on paper. But in terms of money in his account each month, that $250k+/month of pure cash flow is hard to beat)
That sounds awesome, if he's capitalized at $10m. If he's capitalized at $100m, not as great. This is why just citing raw cashflow numbers are meaningless. I just saw an article calling Houston one of the 4 biggest bubbles in the country.
He started about when I did. 14 years ago. Him and a partner both put up $1m. The portfolio was built up by smart buying/selling/refinancing. Their initial money in has been paid back long ago (and the partner bought out). So his annual cash flow is 300% of his original investment.
One of my best friends invests in the same market as me (Houston). His cash flow was $3.1 MILLION last year after all expenses.
Ask me what his appreciation was? Who knows. Who cares
(actually Houston has been on a rocket ship up so my guess is he made $10m+ on paper. But in terms of money in his account each month, that $250k+/month of pure cash flow is hard to beat)
That sounds awesome, if he's capitalized at $10m. If he's capitalized at $100m, not as great. This is why just citing raw cashflow numbers are meaningless. I just saw an article calling Houston one of the 4 biggest bubbles in the country.
He started about when I did. 14 years ago. Him and a partner both put up $1m. The portfolio was built up by smart buying/selling/refinancing. Their initial money in has been paid back long ago (and the partner bought out). So his annual cash flow is 300% of his original investment.
Not surprisingly, you miss my point. I did not doubt he has done well, I'm just pointing out the weakness of cashflow as dollars rather than as a percentage of capital, AKA IRR. A far more interesting metric of his portfolio would be his yearly return on that year's capitalization, not what he started with. Is his money still working hard or not? No right answer, since high returns usually are accompanied by high risk.
It could also read like this;
"When the economy turns and an investment goes diabolically wrong... I will have already got paid..."
It could also read like this;
"When the economy turns and an investment goes diabolically wrong... I will have already got paid..."
I was joking about his accidentally writing "infernal" instead of "internal."
If you "would rather invest in something that has a huge payout in 30 years" then go for it. I have no interest in stopping you, and if that is your goal then more power to you. I just don't support casually dismissing people who have different goals as having "misunderstood" what they should be aiming.
I like the financial analysis but I was trying to really take babysteps with this discussion. Focus on the foundation of any type of investing, cashflows, and then move on from there. I will tell you I love an IRR calculation and throwing some discounted cashflows in there. I think it is fun but if you are buying in an area that out appreciates inflation or your monthly cashflow is insane, you are good anyways...
What is troubling and even reckless is that people have taken these rules and not tried to find great investments in their market but have flocked to already efficient markets (Indy, Memphis, ect.) to try and force their model. The payouts years ago probably matched the risks. All you are doing is trying to squeeze some profits out of a market where you should be seeing much higher cashflow because the appreciation and sale of the property is going to yield little.
@Cody L. Your friend is killing it. I would take that in a heartbeat, anyone would.
@Alexander V. 30 years? Didn't you see my original post... I have already pocketed 150K off the deal.
Me and Tupac agree "I gotta get paid, and thats the way it is.."