(-) cash flow properties have me wondering - what am I missing?
Member since 2021 · 14 posts · 35 votes
(-) cash flow properties have me wondering - what am I missing?
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Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votesCash flow
64 Replies
- 5yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
Originally posted by @Jay Hinrichs:
Originally posted by @Marcus Auerbach:
Very easy to make every deal (even a good one) look like cash flow negative - all you have to do is change every single parameter a little bit to the conservative side! The cummulative effect (lower rents, higher vacancies, a bit higher expenses, PM fees etc, will be enough to make a good deal look like cash flow negative. or the other way, make a bad deal look like it could work. I am sure you have heard of the expression: garbage in, garbage out. So the trick is to not use pessimistic or optimistic numbers, but realistic ones.
New investors are often very concerned to calculate cash flow accuratly (how much exactly for lawn mowing?), but they just budget a small percentage of rent ('someone on BP said 5% is good") to cover all capex without much consideration, which can really range anywhere from almost nothing to six figures on a small multi. This is what really makes or breakes a deal. Future capex needs to be estimated/calculated for every individual property!
Property values have been going up faster than rents over the last 3 years in the Milwaukee metro area - last year rents grew 1.5% and median sales price per MLS +10.26%. (all the details and stats on my Milwaukee YouTube channel, link on the BP profile page). So, yes it is getting tougher every year.
Also keep in mind, you don't need to make all your profit on your first deal, the main thing is to get started. Smaller ROI is okay, as long as you keep it low risk, never risk your principal!
Marcus,
Here is my thought since this is a recurring theme in many markets and with most BP beginner landlords.. they are simply using the wrong math.. they are under the impression its not a deal if it does not cash flow with ONLY 20% down .. well you might have to put a little more down to get cash flow so maybe the metric is now for our current environment 30% down or 40% down is the norm and the number you use in your handy dandy number crunching cash flow calculator put those numbers in and see where you end up.. Now all of a sudden the deals work. There is no rule that says its ONLY a great deal if it cash flows with 20% down.. that's the break in the model and the mind set ..
I personally look at what is the COC if I paid cash.. then work backwards..
For now the formula is broken.
Except, that by increasing the cash out of pocket (DP) you are increasing the cost of the property to the REI and decreasing the CoCR, as well as lengthening the time it takes to recover your cost (DP) and thus start making a profit.
Here's an example of what I'm saying: Given
Purchase Price of Property = $200k
Cash Flow before Mortgage Payment is added to expenses = 1440/MOption #1: 20% DP = $40k; Loan (30 yr) = $160k
Cash Flow after Mortgage Payment is added to expenses = 500/M; 6000/yr
Years to recover cost (DP) = 6 years, 8 months
Option #2: 30% DP = $60k; Loan (30 yr) = $140k
Cash Flow after Mortgage Payment is added to expenses = 610/M; 7320/yr
Years to recover cost (DP) = 8 years, 2 months - 5yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Originally posted by @Joe Villeneuve:
Originally posted by @Jay Hinrichs:
Originally posted by @Marcus Auerbach:
Very easy to make every deal (even a good one) look like cash flow negative - all you have to do is change every single parameter a little bit to the conservative side! The cummulative effect (lower rents, higher vacancies, a bit higher expenses, PM fees etc, will be enough to make a good deal look like cash flow negative. or the other way, make a bad deal look like it could work. I am sure you have heard of the expression: garbage in, garbage out. So the trick is to not use pessimistic or optimistic numbers, but realistic ones.
New investors are often very concerned to calculate cash flow accuratly (how much exactly for lawn mowing?), but they just budget a small percentage of rent ('someone on BP said 5% is good") to cover all capex without much consideration, which can really range anywhere from almost nothing to six figures on a small multi. This is what really makes or breakes a deal. Future capex needs to be estimated/calculated for every individual property!
Property values have been going up faster than rents over the last 3 years in the Milwaukee metro area - last year rents grew 1.5% and median sales price per MLS +10.26%. (all the details and stats on my Milwaukee YouTube channel, link on the BP profile page). So, yes it is getting tougher every year.
Also keep in mind, you don't need to make all your profit on your first deal, the main thing is to get started. Smaller ROI is okay, as long as you keep it low risk, never risk your principal!
Marcus,
Here is my thought since this is a recurring theme in many markets and with most BP beginner landlords.. they are simply using the wrong math.. they are under the impression its not a deal if it does not cash flow with ONLY 20% down .. well you might have to put a little more down to get cash flow so maybe the metric is now for our current environment 30% down or 40% down is the norm and the number you use in your handy dandy number crunching cash flow calculator put those numbers in and see where you end up.. Now all of a sudden the deals work. There is no rule that says its ONLY a great deal if it cash flows with 20% down.. that's the break in the model and the mind set ..
I personally look at what is the COC if I paid cash.. then work backwards..
For now the formula is broken.
Except, that by increasing the cash out of pocket (DP) you are increasing the cost of the property to the REI and decreasing the CoCR, as well as lengthening the time it takes to recover your cost (DP) and thus start making a profit.
Here's an example of what I'm saying: Given
Purchase Price of Property = $200k
Cash Flow before Mortgage Payment is added to expenses = 1440/MOption #1: 20% DP = $40k; Loan (30 yr) = $160k
Cash Flow after Mortgage Payment is added to expenses = 500/M; 6000/yr
Years to recover cost (DP) = 6 years, 8 months
Option #2: 30% DP = $60k; Loan (30 yr) = $140k
Cash Flow after Mortgage Payment is added to expenses = 610/M; 7320/yr
Years to recover cost (DP) = 8 years, 2 monthsJoe I get the math.. its very simple .. what my point is the market does not always allow the math to work at certain numbers and right now in many markets the math does not work at 20% down .. so if thats the metric and the deals dont work then some investors simply wont buy them but others will. And or your cash buyers as there are many will simply be happy making a 5 to 8% COC based on all cash or less .. or more depending on the asset..
- Investor · USA · Member since 2016 · 20 posts · 5 votes5y
@Jennifer Walsh You're not crazy: margins are tight for rentals in the Milwaukee and Waukesha markets. We ran the numbers on 50+ deals before finding one that fit our buying criteria.
I like @Kristin Hafner idea of doing the deal analysis as a short-term rental. Margins can be higher for Airbnb's in some neighborhoods.
- Investor · Hoffman Estates, IL · Member since 2014 · 434 posts · 185 votes5y
Find a different market within an hours drive that works better.
- 5yBonnie Griffin KaakePro MemberReal Estate Consultant · Denver, CO · Member since 2021 · 666 posts · 389 votes
@Derek Peruo You are right, the margins can be higher for short-term rentals. Nevertheless, those crunching the numbers for a STR need to take into consideration the longer term depreciation schedule. You must use 39 years instead of the typical 27.5 for a residential rental. If you miss this, you can be a target for an IRS audit and many tax pros are missing this. On the other hand, a cost seg study can give you extra cash-flow upfront no matter if it is a short-term or long-term rental. This can give you the extra cash-flow to upgrade the unit(s) and increase the rent.
@Jennifer Walsh
Hey Jennifer,
I'm not too far away west of you here in Madison and it's the same situation. It made no sense to me either until I realized that many of the rentals are being purchase by seasoned investors who can pay all cash and are perfectly ok buying 4-5 cap properties with no financing. They know that the area is extremely likely to appreciate 4-6% on average over time, and their likely considering IRR versus monthly cash flow. There's a small number of established investors/families in Madison that control a huge amount of property
- Member since 2019 · 7k+ posts · 4k+ votes5y
here's why you never have a deal: find data from attomdata (or other resources) for your county and city. Then skip anything below 6% cap rate. Focus on above cap rate 8%, in wisconsin,Milwaukee has the most CF.
- Real Estate Syndicator · Milwaukee, WI · Member since 2018 · 1k+ posts · 907 votes5y
Most likely a combination of all the reasons you mentioned. Good returns are tough to come by. Expect to look at 100+ deals to find one that makes sense. There are good deals in those markets, just have to dig deep enough to find them.
- Rental Property Investor · Navarre, FL · Member since 2019 · 913 posts · 640 votes5y
I like the 1% rule and find 0.75% cashflows $400 - $500 a month for me. On brand new construction that minimizes the exposure to old mechanicals breaking.
Problem right now is the market has gone nuts and the rental return has not increased with the price increase. That will destroy your ROI.
@Jennifer Walsh
Okay...hmmmm
So I invest in Nebraska. Houses are selling for over list by minimum 10k-15k. I still bid 10k-15k over. Recently closed on a property that I bid 10k over with an escalating clause of a grand to a max of 195k purchase price. I ended up closing at 190k and appraised at 190k. This means I technically have zero equity. Rents averaged $1500/month. Found great tenants paying $1595. When I was going through the numbers, I knew this property would rent for $1495 minimum and I was okay with that cash flow. Zillow and Rentometer estimates were around $1400. When I listed for rent, some tenants were telling me they’d be willing to pay $100 over my $1595 asking. Not sure how hot the market is in WI but everyone is looking for rent right now. This particular property was a SF 3 bed 3 bath 1450sq ft. What kind of properties are you going for? Are they turnkey? Condos? Multi? Sf? What are rentals in that neighborhood going for? I feel like estimates, although should be underestimated when running your numbers, are going above what you may be thinking they’ll rent for. This could be good for now but MAYBE bad later. That’s why good enough cash flow will help cushion what may happen to market in the future. Don’t mean to be blabbering on and nor am I saying you’re in the analysis paralysis phase but you MAY be. Have you asked any PM around? That really helped me out in the beginning. If all that I mentioned is obvious to you, then you should def look into house hacking. The reason to do so is two fold: 1) you can bid well above asking to score a sale 2) you’ll most likely cashflow...am I right? Ultimately, there is always a way in real estate if you keep asking yourself HOW and continue to keep swinging!
Hi Jennifer, for current markets, chances are that you would overpay to acquire a property or ended up buying one showing cash flow "In Theory" but you would have tenants not paying after few months. I stopped working on SFH, small multies. Feel free to DM me as I feel that I was in the same shoes few months ago, and realized a big time in multifamily investment thru the proper education. I can share my stories. thanks!
@Jennifer Walsh you’re doing it right. The timing now is extremely difficult and frustrating because you and other investors are wanting and willing to pickup a property. I have 3 multiplex and can’t find anything the last 6 months that remotely work positively. But I do have to say everyone who has property (like me) are happy that our current holdings are also higher in value. I just have to be more patient and keep focus until there is a better time or opportunity
- Member since 2019 · 5 posts · 0 votes5y
@Jennifer Walsh I take different approach on rental property. If your mortgage is $700 interest +$300 principal=$1000 I consider $300 going in to my pocket in form of equity. So considering that someone is building your equity and if you keep house for long someone paid it off. I know people who pay $100 out of their pocket but the good side it will paid off in 20 yrs and you paid 24000 on the course of 20 yrs
- Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes5y
Cash and Flow are appropriately both four letter words. And should be banished from any serious investors vocabulary. Im putting on my flame resistant armor now because this is BP heresy right? But hear me out.
The only time cash flow matters as an absolute is if you are living off the income and need to predict your budget. The rest of the time, see below.
As an investor (i.e someone with capital to invest) your job is to allocate your capital in the most efficient manner possible to attain risk adjusted returns according to your goals.
The problem with cash flow is that it is so easily manipulated and so hard to use as a comparative metric that its completely useless for evaluating investments. Increase downpayment, increase mortgage term, reduce interest or go to interest only loans, there are so many ways to manipulate the cash flow. That is why sophisticated and institutional investors (aka people with more money and better math skills, or better accountants) use IRR as a way to compare and evaluate investments.
This takes into account the total return over the period of the investment. It includes sum of cash flows, equity gain and time value of money to generate a real estimate of return. So even negative cash flow properties can have huge positive IRRs and high cash flows can have mediocre IRRs. And IRRs can be compared across investments. You can compare buying bonds or stocks or real estate with each other. And determine the best way to allocate your funds.
Of course there is future gazing involved and assumptions in all of the above but at least you have numbers that may mean something! With is a lot better than c-a-s-h f-l-o-w
- 5yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Originally posted by @Mike B.:
@Jennifer Walsh
Hey Jennifer,
I'm not too far away west of you here in Madison and it's the same situation. It made no sense to me either until I realized that many of the rentals are being purchase by seasoned investors who can pay all cash and are perfectly ok buying 4-5 cap properties with no financing. They know that the area is extremely likely to appreciate 4-6% on average over time, and their likely considering IRR versus monthly cash flow. There's a small number of established investors/families in Madison that control a huge amount of property
there you go Nail on the head..
- 5yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Originally posted by @Account Closed:
Cash and Flow are appropriately both four letter words. And should be banished from any serious investors vocabulary. Im putting on my flame resistant armor now because this is BP heresy right? But hear me out.
The only time cash flow matters as an absolute is if you are living off the income and need to predict your budget. The rest of the time, see below.
As an investor (i.e someone with capital to invest) your job is to allocate your capital in the most efficient manner possible to attain risk adjusted returns according to your goals.
The problem with cash flow is that it is so easily manipulated and so hard to use as a comparative metric that its completely useless for evaluating investments. Increase downpayment, increase mortgage term, reduce interest or go to interest only loans, there are so many ways to manipulate the cash flow. That is why sophisticated and institutional investors (aka people with more money and better math skills, or better accountants) use IRR as a way to compare and evaluate investments.
This takes into account the total return over the period of the investment. It includes sum of cash flows, equity gain and time value of money to generate a real estimate of return. So even negative cash flow properties can have huge positive IRRs and high cash flows can have mediocre IRRs. And IRRs can be compared across investments. You can compare buying bonds or stocks or real estate with each other. And determine the best way to allocate your funds.
Of course there is future gazing involved and assumptions in all of the above but at least you have numbers that may mean something! With is a lot better than c-a-s-h f-l-o-w
Anish EXACTLY but as you point out on BP the overwhelming mind set is I am going to live off of my rental income and quit my sucky day job. And that will allow me time to play with my kids.. this is the dream that guru's sell and in a way what's sold on BP..
the reality for those starting out which is a vast majority of the BP audience is that generating a portfolio big enough with minimum down and max leverage is going to take literally 50 to 100 houses to create that cash flow you can count on to live off of.
the investor who pays cash might get there albeit slowly but unless these folks are in the trench's and can massively scale or conversely live in an area were they can live on 4 to 5k a month its pretty tough..
And given the amount of debt you have to take on to create 2k a year spendable.. it seems lopsided to me taken on the risk / reward ..
- Investor · Granger, IN · Member since 2015 · 195 posts · 129 votes5y
Good points above. I've got two different suggestions. 1. branch out beyond Waukesha. My guess is it is on average a nicer place than many other Milwaukee subs and in the current market pretty pricey. I am sure there are lots of older and still nice subs to pick from in the metro area. 2. Are you finding these on the MLS. If so start networking and find local REIA's to find off market listings. Also in Indiana we (locals) use a 2% rule rather than a 1% and I imagine you can get closer to that in Wisconsin if you are patient. Patience is the key. Lots of houses out there and some okay deals but very good deals are still out there as well. Can you post your assumptions on costs for us. We may find a place you look high in comparison to our experience. Good Luck!
- Lender · PA · Member since 2019 · 535 posts · 461 votes5y
I suggest that you look for off market properties. This is harder work but has a greater reward. Some suggestions:
Here are three methods of finding off-market opportunities that your competition doesn’t know about:
- Cultivate and nurture your connections to property owners and brokers. Since you can’t rely on listing services or online marketplaces to inform you about off-market opportunities, relationships are especially important. You are more likely to hear about an asset on the sale block first if you already keep in touch with potential sellers. And if you learn about it first, you have more time to prepare for the deal.
- Get on buyers’ lists. Through the above-mentioned relationships, you can get yourself placed on buyers’ lists that keep you informed about properties that are quietly up for sale. You’re more likely to discover “,” deals that brokers know about but sellers don’t want to list for fear of alarming tenants or management.
- Become hyper observant. Find off-market deals by discovering them before the seller commits to selling. A property with deferred maintenance or poor Yelp reviews could be ripe for new ownership and management, and a seller looking for a way out will welcome a pro-active lead. The same might be true if an owner has held the property for many years and has been toying with the idea of listing it. Without the rush from competitive buyers, that seller may warm up to an interested investor.
Remember most lenders will only lend on investment properties that have a debt service coverage ratio of 1.0 or greater. 1.0 is the minimum. Banks like 1.25. You calculate D.S.C.R. by assuming a 20 percent down payment or 80 percent financing. Estimate the interest rate and then use a 25 or 30 year amortisation. After you have calculated your principal and interest payment add 1/12 of the insurance and taxes. That is the monthly debt you need to service. Next, calculate the monthly income less 5 percent for vacancies and repairs. Divide the income by the monthly debt service and you have a D.S.C.R.
Example: 1200.00 income 1150.00 debt service = 1.04 this is marginal. So make sure you know if the property can be financed prior to your offer.
If the property does not work values are rising faster than rent. This is a problem throughout the Untied States at the moment. Remember most lenders do not like small loans.So messing around with $100,000.00 properties is for someone with access to their own capital (or a partner who has capital)through savings, HELOC or borrowing against their 401k. These lower value properties located in Urban core areas are hard to refinance but often have good cash flow.
Good luck!
- Tucson, AZ · Member since 2021 · 15 posts · 6 votes5y
The same is true here in Tucson, unless you are willing to invest in a war zone. With the seller's market, I'm not sure you can leverage yourself and still cash flow here, at least I haven't found a nice enough property that doesn't need to be gutted to make that happen. Which makes me wonder if really in a seller's market it's better to just pay cash to achieve a cash flowing property, rather than leveraging yourself and having a couple negative cash flow properties for several years. The latter seems too risky for me.
- Tucson, AZ · Member since 2021 · 15 posts · 6 votes5y
The same is true here in Tucson, unless you are willing to invest in a war zone. With the seller's market, I'm not sure you can leverage yourself and still cash flow here, at least I haven't found a nice enough property that doesn't need to be gutted to make that happen. Which makes me wonder if really in a seller's market it's better to just pay cash to achieve a cash flowing property, rather than leveraging yourself and having a couple negative cash flow properties for several years. The latter seems too risky for me.
- 5yJoshua ChristensenPro MemberReal Estate Broker · Albuquerque, NM · Member since 2015 · 285 posts · 232 votes
Jennifer, there are a lot of deals out there that only work when bought cash without any debt leverage. The markets are crazy hot right now and it is incredibly challenging to pencil cash flowing deals that are listed. You have to find off market deals that are distressed and need some updates to improve the rents or have a larger investment in them to create the flow.
The other thing to remember when looking at these deals is that you're looking for deals with some room for rent increases and improvements to increase the value. Run your numbers off of your conservative growth model and you may need to pay out of pocket for a few months to a year to get the property up to snuff.
There are a lot of people who won't touch a deal unless it cash flows day 1. In the current market that is not impossible, and it can difficult to find. Be patient and don't let your emotions cloud your judgement.
- Atlanta, GA · Member since 2014 · 19 posts · 14 votes5y
@Jennifer Walsh
(Hi Jennifer, please give us the best deal that you saw, where the numbers still didn’t work and see what we come up with...) But with that said...
I agree w/ Marcus Auerbach, the most important thing is to get started. I bought a primary residence and turned it into a rental after about 8 years of living in it.
As a rental, it was a terrible deal. PITI $350 and the rent collected used to be $300/mo, but now it's $450/mo. So once you add in the expenses that I have incurred for maintenance, that $1200/yr potential profit is always gone or nowhere near the $1200.
But... through owning it for 17 years, I’ve built up a significant amount of equity (maybe around $20k-$30k. So now that I know my niche, my target areas, my numbers and my overall goals, I can now sell that property and 1031 into something that takes that negative-to -$100 cash flow every month up to $500/mo positive cash flow on a higher value property closer to the city of Atlanta.
You should never buy a bad deal on purpose, but with that said, don't be afraid to buy something and learn how to manage it and see how to landlord. As you can see, that rental was a terrible cash flow deal, but the tenants paid down the debt for years and now I can cash that in with the new knowledge that I have and I actually feel blessed for keeping that property so long. So even a bad cash flow deal has a silver lining if you have enough cash from somewhere else in order to weather the storms that will occur (I only had a $350 mortgage which was easy to maintain with or without a tenant-if you are going to take on PITI of $800 or more, you may want to really consider wether or not you would be able to withstand 6 months of no rent for whatever reason).
Other ways to think about are
1. Go to real estate meet ups and see what and why other landlords are paying what they are paying and where they are buying (emulate other successful landlords even though they may have a different strategy because they are in later stages of investing-you still probably will be better off following the smart money)
2. Consider duplexes where the PITI is paid by one side and the other side has the maintenance, and profit (or triplexes or quads)
3. Consider higher cash flow markets within driving distance (1 hour at most-you can be an out-of-state investor with property management in place if you want, but if I were you, I would manage the first one myself just so I could see what the property manager is getting paid to do).
4. Always remember, the higher the cash flow, the lower class the property probably is, so look for that happy medium of a working class stable neighborhood
I hope this helps. Be blessed. You’re on the right track with real estate, so just keep moving forward and one day it will all make sense (and there’s still plenty I don’t know-but it still makes sense to buy).
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