How important is CASH FLOW if it is a 3-5 year play?

18 Replies

I know that there are many investors who strictly invest for cash flow.  When I tell them that my partner and I each make about $100 per month per property they consider that way too little and far too risky for it to be a good investment property.  I recognize that $100 per property is not enough to get out of the rat race any time soon, however, our investment strategy is not necessarily the monthly cash flow.  Our strategy is a 3-5 year flip that when you add up the cash flow, the tax savings from depreciation, the mortgage debt pay down, and the fact that we bought it under market value and that we are selling it on a lease option so we don't need to pay realtor fees and have minimal closing costs, our average total profit over a 3-5 year period is round 60k per property that my partner and I split.  So for me, while cash flow is important, especially to show banks that the properties are profitable in order to get loans on them, I think that an investor should look at the investment as a whole and not just invest solely for cash flow.

I would love to get the opinion of the BiggerPockets community on how important cash flow is to them in determining which properties to invest in.

the major supposition is your counting on lease option purchasers to follow through.. most that do this know that you will have some follow through and some will leave and probably leave you with a bunch of cap ex.. 

But I am not in the cash flow is everything camp personally.. I  mean I buy vacant land.. and other non cash flow deals.

but I have a way to value add ( build on them) or a pretty strong idea that path of progress is going to run into us.

really depends.. and I agree building wealth at 100 to 200 a month at a time.. you take on a ton of debt for very little actual return.. But if the market smiles on you .. then when you sell you can reap the rewards.

but do remember unless your going to 1031 and keep rolling up you wont really see that cash.. and if you want the cash then you will just give back your tax benefits in the form of recapture.. but you will always have the debt pay down from your lease tenants.. .. 

and in the old days if you could get a tenant to pay off your house.. then that was OK and I still think that is OK in strong markets.. 

The correct way to look at any investment is IRR. This take into account accumulated cash flow, final sale price and time value of money. Its the way major corporations and banks make investments.

Originally posted by @Anish Tolia :

The correct way to look at any investment is IRR. This take into account accumulated cash flow, final sale price and time value of money. Its the way major corporations and banks make investments.

that's why IRR in the bay area is so much greater than most areas.. at exit the huge appreciation tips the scales.. at least if you sell in the right cycle. I was just down in Mt. View and talking to some googlers and they were telling me homes by Google campus 5 years ago for a 1k sq ft older little bungalow was 500k.. today 2 mil plus.. so what kind of IRR would you get if you bought 4 or 5 years ago and sold Right this minute.. cash flow is negative a few hundred a month.. so what.. when folks say don't buy because of negative cash flow ever. they are not working in high appreciating markets.

@Jay Hinrichs yes our number one goal is for the tenant to exercise their option to buy the property. However, if they do not, we have the option to re-option it to them, or find a new end buyer and lease option it to them, or sell the property on the open market, or just plain rent it. 

Yes there will be some turn over costs, however, if we re-option it to someone else, we can likely get all of our turn over costs reimbursed through the new option fee of $3900. Then our plan is to do a 1031 exchange by grouping several of these properties together in 2022 into larger deals that can create more cash flow and where we can delay paying taxes, hopefully forever. 

Right now we have 18 lease optioned our with another 6 in the works. By 2022 I plan on having around 40-50 that come due that year all with an average of 60k equity in them at that time. So I am will to cash flow a little now for a big payoff in 2022. And because we are only selling them for 5-7% higher than current market value, it is very likely that our tenants will have a lot of equity when they go to exercise their option to buy which is an incentive to them to exercise it. And if they don’t we will likely end up making more money. But we really do try to help them get ready to buy our properties by connecting them with a mortgage company that helps repair their credit so they can get a loan.

You also have to consider you don't know whats going to happen in 3-5 years. What if there is a downturn and your property values are cut by half? Well at least you still have those leases running at the same rent. Unless you're trying to do an immediate flip, I as an investor would like to see solid cashflow as well if you're talking about a couple years for the end goal.

Originally posted by @Shiloh Lundahl :

@Jay Hinrichs yes our number one goal is for the tenant to exercise their option to buy the property. However, if they do not, we have the option to re-option it to them, or find a new end buyer and lease option it to them, or sell the property on the open market, or just plain rent it. 

Yes there will be some turn over costs, however, if we re-option it to someone else, we can likely get all of our turn over costs reimbursed through the new option fee of $3900. Then our plan is to do a 1031 exchange by grouping several of these properties together in 2022 into larger deals that can create more cash flow and where we can delay paying taxes, hopefully forever. 

Right now we have 18 lease optioned our with another 6 in the works. By 2022 I plan on having around 40-50 that come due that year all with an average of 60k equity in them at that time. So I am will to cash flow a little now for a big payoff in 2022. And because we are only selling them for 5-7% higher than current market value, it is very likely that our tenants will have a lot of equity when they go to exercise their option to buy which is an incentive to them to exercise it. And if they don’t we will likely end up making more money. But we really do try to help them get ready to buy our properties by connecting them with a mortgage company that helps repair their credit so they can get a loan.

hope it all works.. my experience has been once someone leaves a home to get it retail ready is anywhere from 5 to 20k per house.

selling above market is frowned upon and looked at as subprime and taking advantage.. but be that as it may.  as long as things are humming along in 2022 and the dooms day folks don't have us in a recession were the houses are actually worth less than you paid for them or only what you paid for them.. then the scenario should work fine.. regardless worse case is they are rentals.. but I just would not build a business plan around some big upside and promise it to other investors.. as they may be disappointed if it does not work out as you hope.. I think were legal and within the scope of the law and NOT selling them today for more than they are worth.. is fine..

your buyers if they are paying more than they are worth are not going to get financed once they get their appraisal.. and or in 2022 if the market has gone up its moot anyway you might really have sold for too cheap..  we all don't have crystal balls into the future.. but I think the only risk in this is sub prime is sub prime and that always carries risk.. 

@Jay Hinrichs the option price is higher than the current market value. But 5-7% of appreciation in my market is really conservative. Most of the houses we lease optioned out last year have a current market value over and above the agreed upon option price. 

Here is a link to one of our houses that we purchased for 130k, put about 12k into the rehab, and lease optioned out for 175k. The Zillow estimate (even though Zillow is usually is usually off) is around 186k currently.

https://www.zillow.com/homedetails/955-S-Drew-St-MESA-AZ-85210/7632273_zpid/

Here is another one that we purchased for 69k, we put about 38k into the rehab and we lease optioned it for 150k, the Zillow estimate today is 148k and there is still around 4 years left on the option.

https://www.zillow.com/homedetails/595-S-Main-Dr-APACHE-JUNCTION-AZ-85120/8667008_zpid/

Here is another one that we bought for 55k, we put 5k in the rehab and we lease optioned it for 75k. Current Zillow estimate is 78k and they still have 4 years left on the option (this one was our first one so we didn’t build in enough appreciation and we will only make around 12k each on it but it got us off to the races).

 https://www.zillow.com/homedetails/121-W-Harding-Ave-COOLIDGE-AZ-85128/8685741_zpid/

So you can see that our model is pretty simple and is attractive to people who want to own a home but are not able to get a mortgage on one right now but they can lock in a price today, plant their roots, and work towards getting their credit repaired. Our tenants tell us how happy and grateful they are for the opportunity to get one of our lease option properties.

@Shiloh Lundahl Congratulations! You've do something that 90% of the real estate investors never do. Look at total returns. This is also why sophisticated investors only look at IRR because one has to look at an investment over the entire holding period by accounting for the magnitude and timing of cash flow.

The "investing for cash flow only" crowd is not investing high growth markets like Cali, NY, WA and other prosperous parts of the country. As @Jay Hinrichs points out, if one includes total returns then one starts understanding why there is so much institutional money flowing around in more expensive markets. 

It goes without saying that one must exercise caution and find a balance between liquidity - cash flow - and maximizing long-term returns. There is no long-term (maximized long-term returns) without the short-term (liquidity through cash flow). 

You have a good strategy because you are trying to look at all facets and not solely one area. Also, I'm assuming you have a safe, stable job and diligently save money. That alone puts you in the upper echelon.

Originally posted by @Shiloh Lundahl :

@Jay Hinrichs the option price is higher than the current market value. But 5-7% of appreciation in my market is really conservative. Most of the houses we lease optioned out last year have a current market value over and above the agreed upon option price. 

Here is a link to one of our houses that we purchased for 130k, put about 12k into the rehab, and lease optioned out for 175k. The Zillow estimate (even though Zillow is usually is usually off) is around 186k currently.

https://www.zillow.com/homedetails/955-S-Drew-St-MESA-AZ-85210/7632273_zpid/

Here is another one that we purchased for 69k, we put about 38k into the rehab and we lease optioned it for 150k, the Zillow estimate today is 148k and there is still around 4 years left on the option.

https://www.zillow.com/homedetails/595-S-Main-Dr-APACHE-JUNCTION-AZ-85120/8667008_zpid/

Here is another one that we bought for 55k, we put 5k in the rehab and we lease optioned it for 75k. Current Zillow estimate is 78k and they still have 4 years left on the option (this one was our first one so we didn’t build in enough appreciation and we will only make around 12k each on it but it got us off to the races).

 https://www.zillow.com/homedetails/121-W-Harding-Ave-COOLIDGE-AZ-85128/8685741_zpid/

So you can see that our model is pretty simple and is attractive to people who want to own a home but are not able to get a mortgage on one right now but they can lock in a price today, plant their roots, and work towards getting their credit repaired. Our tenants tell us how happy and grateful they are for the opportunity to get one of our lease option properties.

your just flipping.. those houses would sell today for what you sold them for ?  or close to it you could hold one year and sell and get cap gains and not take the risk..  that's one thought 

@Omar Khan  I have a therapy practice that fully supports our family. Our real estate business is meant to build our wealth. We don’t really need the cash flow from the properties to support us. But it does help to get more loans and in case we need it for our real estate.

@Jay Hinrichs we look at these properties as long term flips. Because we do it this way, we can sell the properties for a little over market value, we don’t have to pay realtor fees, we don’t have to pay concessions, and the tenant pays down our mortgage for a few years which increases the margin, and then we cash out.

Originally posted by @Shiloh Lundahl :

@Jay Hinrichs we look at these properties as long term flips. Because we do it this way, we can sell the properties for a little over market value, we don’t have to pay realtor fees, we don’t have to pay concessions, and the tenant pays down our mortgage for a few years which increases the margin, and then we cash out.

as long as the lessor buys it that's true.. my experience with lease options is less than 50% of them will actually execute.. many will just up and move and some you will evict and some you will pull through the knot hole.. just human nature really.  but lets see how you do.. its all supposition at this point.  And like I said worse thing is you just have a rental. 

@Shiloh Lundahl

The question is completely dependent on each individuals current situation and future goals. Your plan appears to fit your situation very well and executed properly has the potential to reap large rewards. @Omar Khan said it well when he said "You have a good strategy because you are trying to look at all facets and not solely one area. Also, I'm assuming you have a safe, stable job and diligently save money." The latter appears to be true judging by your BP profile. 

I live and invest where medium home prices are $950k and I only buy deals that cash flow - minus a really good flip with huge upside potential and short term hold. With that said, I would take deals all day that cash flow a $100 a month in my area - but only because I have the added value of monstrous apprection and I am a buy and hold (10+ years) investor. Personally I would not do a deal for $100 a month on a $120k property - but this is situation dependent as I mentioned above. 

@Shiloh Lundahl Glad you brought this up...my position is counterintuitive to what 95% of investors base investment decisions on (cash flow). The irony is 95% of investors are not full time....meaning they have W2 income to cover expenses...and living off cash flow from RE alone is very risky (you must have other revenue streams). I wrote a lengthy blog on this recently; the bottom line is that investing is about control, not instant cash. RE is a stable asset...future equity will be there even if there is no appreciation....your tenants will eventually create a nice equity nest egg for you. I think a lot of people miss the boat and are passing up on fantastic opportunities.

More for us I guess ;)

@Shiloh Lundahl

Hey! I agree wholeheartedly with the way you are doing your calculations and taking everything into consideration.

I just want everyone else to know that just because you use a sophisticated calculation like the IRR, it doesn't mean you can't treat it the same way as you the majority of most Investors on this Blog does which is assume that the Cash Flow for the 1st year is exactly the cash flow for the years after for life!

Here is an example where you put in $70k to buy your Investment Property and you receive $500 per month. You assume you get that $500 per month for the next 10 years. The IRR Looks like this:

So yes, you can do JUST a Cash on Cash Return (CoC Return) and get the same answer as a 10 year projected IRR as in the image above.

Also, because you are using a 10 year projection schedule, you really VISUALIZE the Cash Flows. That really tells you a lot! It tells you that you are making the assumption that your $500 per month is for the next 10 years per month!

But if you do the CoC Return..... I think a number of investors just don't have that kind of visualization. It's almost something they use which tells them... hey... it meets a number I had in my head and that means I pull the trigger!

BUT.... you can't calculate using CoC Return what if scenarios such as what happens if my Cash Flow goes up roughly 3% per year and my Investment then can be sold with a Return of $80k?

Try that with your CoC Return!

But it's really easy with an IRR. It then looks like this:

Now the numbers look like this:

CLEARLY it would be better to target properties where you would have increasing rents which then gives you some appreciation.

Notice that the CoC Return can't change. It's too simple and tells you NOTHING about the future... which by the way, even a Squirrel knows about the future since he has to put his Nuts away for the winter or he may starve.

So, we really ALL... that means all the readers of this posts and everyone on BP and every Investor whether or not you are a RE Investor or Stock Investor..... learn IRR. Please!

Why would you not want to learn IRR? I know it looks hard.... but really...

I like to use a famous person's quote on why learn IRR:

"We choose to LEARN Internal Rates of Return (IRR) and do the other things, not because they are easy, but because they are hard; because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one we intend to win, and the others, too."

haha! I'm sure the readers of this post gets the point.

It depends what strategy you are employing.  We do 95% Lease Purchase or things on terms so cashflow is not our primary goal.  We might decide to stay in a deal if we're only breaking even or getting less than $100/month in cashflow ONLY IF there is a HUGE Back End.  That would be when the buyer gets their own loan of course.  We have buyers that are cashing out of deals now so yes it happens.  It's all about setting the buyer up for success at the start.

There's a lot of systems and strategies that an investor can employ but we have it pretty locked in at 2 deals/month averaging $70,000 per deal.

Hope that helps @Shiloh Lundahl , great question,

Chris Pre