Equity build up rather than Cash Flow, why not?

53 Replies

Most investors favor CF rather than equity build up.

The advice is get a mortgage as long as you can (30+years) so you can have a few more hundred dollars in CF.

This neglects the fact that you pay more than three times the amount of interests on a 30 yr loan rather than 15 yr over their respective life.

On a 15 yr, you build up equity (=wealth) quite fast, which is a cushion in case something goes wrong.

Paying a 30 yr faster is not equivalent to a 15 as the portion of interest on your main payment will always be higher.

Investing for equity build up is not as 'flashy' as for CF since you need to live with slim to none CF.

However you actually build wealth faster, hence that is my decision.

I wanted to start this topic to see if others invest like me as we seam to be the minority.

If something goes wrong, say you lose your job at the same time you have a vacancy, equity will not feed you isn't it? Cash in the bank will.

If you have a goal to own many properties then you need the cash to put into each new acquisition. If you are paying 5% to borrow money and you can make 10% on that money then you want to pay it off as slowly as possible. Right now rates are low so it makes sense to lock down those 30 year fixed rates. Later when rates have gone up you will want to concentrate your paydown efforts on your newer, more expensive loans. If you are at or near your goal number of properties then equity pay down certainly makes sense.

@Francois D.

I'm definitely in the cash flow camp. You mention equity being wealth, but it's only wealth if you are going to access it (ie borrow against it or sell). Otherwise, equity really gives you no benefit.

I like the idea of defining wealth as how long I can pay my expenses without working. If you have enough cash flow, that can be indefinite.

Totally agree with @Wendell De Guzman , equity can't pay bills, cash flow can. If you budget for expenses and vacancy correctly and still have cash flow then fluctuations in the market shouldn't really bother you... if you're relying on equity, a market correction would hurt.

Not to mention that people big in asset protection would say you are better off having little equity so there is nothing for someone to try to sue for.

Just my $0.02.

Maybe equity can't pay your bills, but a home equity line can. And even if you do have to draw on it, the interest rate is going to be at least competitive, if not better, than a 30 mortgage.

So no your approach is not crazy. I would argue, in fact, that it is the most common strategy people have followed in this country for decades. On a small scale, this is what you are doing when you pay off your house prior to retirement.

A combination of equity and cash flow is best IMO. I like cash flow, because it is allowing me to grow (or pay bills), but equity helps me to sleep at night knowing I am not as vulnerable to changes in market rent.

You can't eat equity when times get rough. Cash Flow is King. [add another catchy phrase here]...The people who go broke in this business go broke because they can't pay their debt. Cash flow is what pay's debt. Every time.

Medium cmp1512262668Chris P., Mid Georgia House Buyers | 478‑953‑SELL | http://www.midgahousebuyers.com

Im a small timer just getting started. But it's obvious cash flow beats equity any day of the week.

You can get 30 yr fixes, and on down the line use cash flow to pay the mortgages off faster, but the 30yr gives you the option during lean times(loss of employment) new roof etc, to pay those out of cash flow, and not your own pocket. As the old saying goes, CASH FLOW is king, as it gives you flexibility.

Maybe equity can't pay your bills, but a home equity line can. And even if you do have to draw on it, the interest rate is going to be at least competitive, if not better, than a 30 mortgage.

Really? You can get a HELOC cheaper than a OO loan??

A lot of people commented about the benefits of CF over equity and while one member mentioned both- yes, I try to buy at a good price when possible, usually in areas I expect will appreciate, BUT those things are harder to predict and depend on the market more than CF IMO.

A 15 year loan might make more sense if you buy 1 house- but if you are trying to build a portfolio, it absolutely does not.

Originally posted by @Pete T. :
Maybe equity can't pay your bills, but a home equity line can. And even if you do have to draw on it, the interest rate is going to be at least competitive, if not better, than a 30 mortgage.

Really? You can get a HELOC cheaper than a OO loan??

A lot of people commented about the benefits of CF over equity and while one member mentioned both- yes, I try to buy at a good price when possible, usually in areas I expect will appreciate, BUT those things are harder to predict and depend on the market more than CF IMO.

A 15 year loan might make more sense if you buy 1 house- but if you are trying to build a portfolio, it absolutely does not.

Well, that depends on what repayment term we are talking about, doesn't it?

Can I take a draw on an equity line (to get past the sort of short-term issues mentioned above, like loss of employment or emergencies) and end up paying a lot less than with an OO loan over 30 years? Sure can.

There can be any number of reasons why the OP's scenario might work better for him, or any other investor. I might be very confident of my income over the next 15 years, for example, but not over the next 30. It is an individual decision, and there is no globally correct answer.

In my case, I have 3 properties. I'd like it to be 10. I have no interest at all in 30, or 300. And I don't need to pull any income out for the foreseeable future. I should be able to get to 10 solid properties, that are entirely paid off, by when I retire in 20 years. And those properties will then represent a small, albeit important, portion of my retirement portfolio.

Like I said, it depends on the investor.

One thing nobody mentions is that in 15 years the CF goes up considerably. So the CF is more over a total life of investment of 30 years.

For people with a job and planning to keep it, it is a better strategy, for people wanting to get out of a job asap then the immediate CF makes sense.

@Francois D. when I started investing I had the same opinion, but then my banker explained to me that with 30 year loans my DTI is lower and I can get approved for more in the future. So I take out 30 year loans, but pay them as they were 15 years.

Medium second city real estate logo   white close upBrie Schmidt, Second City Real Estate | [email protected] | http://www.SecondCity-RE.com | IL Agent # 471.018287, WI Agent # 57846-90 | Podcast Guest on Show #132

@Brianna Schmidt

Great point, I never thought about the decreased payment with a 30 year mortgage being important to DTI. That lower payment will also decrease the necessary cash reserves with loan 5-10 when you need 6 months reserve for each property. Of course properties owned outright would be even better for DTI and necessary cash reserves. Something to think about on 15 vs 30 yr though.

Originally posted by @Francois D. :

Investing for equity build up is not as 'flashy' as for CF since you need to live with slim to none CF.

However you actually build wealth faster, hence that is my decision.

That would depend on your definition of wealth. To me, wealth is being able to live with out having to work. Cash flow is going to give me the passive income which will allow me to not work, not a lump of equity.

Originally posted by @Richard C. :
Maybe equity can't pay your bills, but a home equity line can. And even if you do have to draw on it, the interest rate is going to be at least competitive, if not better, than a 30 mortgage.

So no your approach is not crazy. I would argue, in fact, that it is the most common strategy people have followed in this country for decades. On a small scale, this is what you are doing when you pay off your house prior to retirement.

Richard so you'd siphon your equity off to pay your bills? perhaps that may be a decent short term solution however the accruing balance will need "cash flow," to pay it down eventually you'll have to sell your assets to cover your liabilities.

Lines of credit are generally based on a fixed margin + prime so if rates rise your rate will rise instantly. Its not like ARM mortgages that only adjust annually. Prime driven products like credit cards and lines of credit are based on the monthly prevailing rate.

Medium new american funding logo  Albert Bui, New American Funding | [email protected] | 949‑514‑5106 | http://albertbui.com | CA Lender # 345453, WA Lender # 345453, TX Lender # 345453, TN Lender # 345453

Originally posted by @Brant Richardson :
@Brianna Schmidt

Great point, I never thought about the decreased payment with a 30 year mortgage being important to DTI. That lower payment will also decrease the necessary cash reserves with loan 5-10 when you need 6 months reserve for each property. Of course properties owned outright would be even better for DTI and necessary cash reserves. Something to think about on 15 vs 30 yr though.

I used to let clients know that this strategy was best for their over all plan especially who get lured in by the 10-15 Term fixed loans who cant understand why they dont qualify for another loan after using these principal rich products. They picked the most cash flow deficient product possible. At the end of the day, like its mentioned in the rich dad books, cash flow is king.

The reserves concern is also mitigated with 30 year fixed or interest only products as well.

Good note!

Medium new american funding logo  Albert Bui, New American Funding | [email protected] | 949‑514‑5106 | http://albertbui.com | CA Lender # 345453, WA Lender # 345453, TX Lender # 345453, TN Lender # 345453

Originally posted by @Francois D. :
One thing nobody mentions is that in 15 years the CF goes up considerably. So the CF is more over a total life of investment of 30 years.
For people with a job and planning to keep it, it is a better strategy, for people wanting to get out of a job asap then the immediate CF makes sense.

I used to think like that too when I was in my first year of mortgage lending in terms of my personal mortgage philosophy for borrowers. Once you see people who have emergencies, medical concerns, job losses, or divorces you soon realize that equity is not so safe after all because this stuff happens all the time. Any one of these occurrences can affect your cash inflow and threaten your equity position not to mention other risks as well such as litigation and market down turn.

Everyone will hopefully find their fine balance of:

- liquidity and liquid reserves

- asset/equity growth goals

- debt management and cash flow management by strategically managing loan terms, notes payable, allocating, shifting, and replacing the more expensive debt instruments with less costly and better terms (fixed, no balloons, non interest rate sensitive)

- tax planning - recoop losses from your financial bucket to be redirect to higher purposes or returns

- estate tax planning - if you're over 5.34 mil and cannot siphon off your wealth quick enough through the 14k gift allowed annually per person

- risk management - since each person has their own risk tolerance for each of the above categories

To focus on just equity growth with out considering the other areas of planning may be very risky but thats just my opinion.

Medium new american funding logo  Albert Bui, New American Funding | [email protected] | 949‑514‑5106 | http://albertbui.com | CA Lender # 345453, WA Lender # 345453, TX Lender # 345453, TN Lender # 345453

There's an old saying that "you can't eat equity". That pretty much sums it up.

@Bryan L. But you can borrow against it!

A development family that I'm familiar with is in the third generation of leadership. The founders philosophy was to have a loan with as short of an amortization as possible on every deal in an effort to build up equity as fast as possible. They didn't care about cash flow because they knew that in 10 years they would have paid off assets that would generate massive cash flow for life. Needless to say this worked very well for them now they use their own cash for every development deal instead of getting loans.

Maybe not everyone's cup of tea, but each strategy works and you need to pick an approach that aligns with your personal short and long term goals.

Derek Carroll, NorthMarq Capital | [email protected] | 315‑558‑8332 | http://www.realestatefinanceguy.com

@Derek Carroll - Yep, as long as your cash-flow is good. But, if the cash-flow goes bad for what ever reason, try getting a loan then.

There's another old saying that "you don't want to be equity rick and cash poor".

When I first got into this biz, I was all about building up equity, and not so much concerned about cash flow. Then the market collapsed, my cash-flow got bad, and the banks stopped lending. It was not fun.

Your analysis is correct when considering one property. If you want to accumulate as many properties as possible, realize that acquiring rental properties is like a domino effect. Properties need 2 years to season before they take care of themselves from an income to debt ratio (assuming you are buying cash flowing properties). You then buy more every two years. By getting 30 year notes you can buy more initially then you have more that are seasoned in two years so you can buy more then and the domino effect begins. Why not get 30 year notes and make extra payments to pay off in 15 years, you would not pay that much extra by paying an extra 3/4% in interest for 15 years but your credit reports would show lower debt which means you can accumulate faster?

Over the years I was in the 15 yr camp as well. This did allow me a lower interest rate. The funny thing is since then there have been many refinancings and credit lines.

It used to be having equity made your balance sheet look good but that doesn't seem to matter much to bankers anymore; it is all about ability to service the loan.

It seems to be an individual thing. You would have a hard time financing a San Francisco property over 10 years but you might one in Ohio.

I have worked with successful investors from both camps and both philosophies work. The guy that mortgaged to the hilt had a more robust lifestyle and has been bankrupt. The guy with F&C properties is a powerful force when financing is tight and when cash talks.

That was are philosophy when we bought our first investment house!! We figured since we wanted everything paid off in 15 years. We might as well out them on 15 year loans with an lower interest rate etc. That worked out well except for one small problem it increased our debt to income. We couldn't continue this "philosophy" and continue growing as rapidly as we wish.

@Richard C. the interest rate is going to be at least competitive, if not better, than a 30 mortgage.

was the original quote, which is just not true. Also, everyone saying you can borrow against your house? Sure as long as you qualify- the same as you would for a new purchase- so the advantage is much smaller than it is made to be. Finally, if you are borrowing against your home, you just lost that "advantage" you had in interest rate from the 15 yr loan which reduce CF, increases DTI, and slows growth. If you invested the money available the same, you wouldnt be way ahead in 30 years w/ equity investing bc you would have a lot more house and a good portion of them paid off- which greatly increases the CF they provide.