Understanding Cashflow. What is good cashflow?

Question

Hi All,

I'm trying to understand cashflow. I'm looking to invest in the Canadian market. There are many articles on the internet that show as little as 1-2% of property investments cashflow. I find that number staggering considering the billions of dollars of both institutional and retail money invested in real estate every year.

I'm trying to understand cashflow a bit better. Let's imagine I have $100k to invest in a $300k property. Over a 20 year period my mortgage + costs is $1600 a month. My rental income is $2000 per month. I'm making $400 in cashflow. Following a similar model, imagine I put 5% down. All of a sudden by mortgage payments are $2200 per month over 20 years. The property is in negative cashflow.

I clearly need to understand this process better. Is cash flow down to the down payment versus debt most of the time? In which case, if you have a wad of cash it makes sense to invest in real estate. Why?

A $400 cashlow, is approximately a 5% yield on your $100k investment or annum. If you put the funds in a savings account with a 5% return, compounded over 20 years, you will get back $270k. Lets take a look at the property investment.. Assuming the property appreciates at a modest 1% a year, the $300k property is now worth $366k. The difference in investing in the savings account versus property is now $96k making the property worthwhile. This is a crazy simple example. I'm trying to understand 1) how is a cash flowing property defined? 2) why so many people invest in real estate given the alternatives.

Thanks all

Brian Geiger · Answer

@Rory Galvin

I recommend that you read Frank Gallenelli's book on "What Every Real Estate Investor Needs to Know about Cashflow". It is a really good book and it can help you answer the question you posed.

Rory Galvin · Answer

Thanks a lot Brian and Michael! I'll continue researching.

Michael Henry · Answer

@Rory Galvin I will try to answer your question but first in terms of your example above the math doesn't work because it is not a good deal. What you have to understand is that buying real estate as an investment is subjective. On one end you have cash flow and on the other end (let us say) security. Most expensive single-family homes do not make sense as an investment unless you can find a deal. This is one of the reasons why people invest in real estate because of the opportunity that can be had if you know what you are doing. On the other hand, I person might purchase that some property as you described above because he/she might already have large savings and is heavily invested into stocks and is looking to diversify.

Now to your questions, I will define cash flow as the money left over after all expenses. You might hear an investor say "I want to net (or cashflow) $200.00 per door". This means if they purchase a duplex they want to cashflow  $400.00 per month. Another investor might say I want a 12% cash on cash return. In this case, the investor cares more what his/her return on investment on the cash they have in the deal and not necessarily the purchase price.

Lastly, remember investors' investment in different locations from where they live because the ROI is to low for their liking where they live. If you can't find a deal that you like in Canada you might want to look elsewhere.

I hope this helps and adds value.