I know this title might be confusing but this is what I tell new investors or friends when I meet with them.
Cashflow Should Not be the only thing you Consider when Buying Rental Properties. Like many I started my Real Estate Investing Journey obsessed with the idea of Cashflow and gaining my own Financial Freedom. I mean in theory it makes perfect sense, If I could create more cashflow than my monthly expenses. Than theoretically I would be financially free. I wouldn't have to work another day in my life doing things that I didn’t want to do.
I think a lot of other new investors come to that conclusion as well. If I could get X amount of rental properties bringing me this amount of cashflow monthly, I'll be financially free. While I think cashflow has its purpose, it’s the way we get to the heavy cashflow and financial freedom that I have a different perspective on.
I see this with a lot of friends, beginner real estate investors and others on platforms like Bigger Pockets. As I did my first couple of years, a lot of these investors want to invest in markets that are really cheap to get into but have high cashflow
I know friends who bought homes in states like Ohio for 50K, and it rents for $800/month. This easily achieves the 1% rule which means its rents are 1% of the total purchase price.
And theoretically this would be a great deal. The problem with these cheap rentals are that when you really start to look at the true cashflow. After all the headaches, maintenance and management issues it doesn’t end up being much. And then when you go to sell the property after you realize that you end up selling it for about the same as what you paid for it. That's why I don't invest in these markets…..for now.
A couple of reasons I don't like investing in cheap markets. #1) a lot of times when the rents are lower your property has a lot more issue and headaches with the tenants, they are generally more challenging to manage.
Another reason I don't like them is that one repair can completely wipe out your cashflow for the year. If your rents are 1000/month only call it 20% of that is kept from cashflow that amounts to $2400 for the entire year. One repair like a furnace or electric panel will eat up all of that cashflow. Let's cross our fingers and hope that we don't have any issues with larger ticket items like the roof or sewer.
I also don't mind putting nice things into a home when it raises the value of the property but in a lot of these cheaper markets that's the thing it doesn’t increase the value. The biggest reason why I don't like cheap markets is because of the appreciation. That's the trade off markets that have a high cashflow right out of the gate typically don't appreciate. If I buy a house for 80K today chances are its going to be about the same price in 10 years if I go to sell it or refinance.
So these are some of the reasons I don't like cashflow markets. Now let's talk about what I do like……the high appreciation markets. If you buy properties in these markets, like Phoenix. These markets give you the best chance to build your net worth. Let's look at what happened from 2019 to 2023 in the Phoenix market.
If you purchased a home for 300K in 2019 chances are that home almost double in value in the 4 your period up to 2023, that same home is probably worth about 550K today increasing your net worth 250K.
That's just one house. What if you owned 5 properties. If each of these properties went up by 250K in value your net worth would have increased $1.25M. Not bad and for most of us that would easily surpass our income over that same period. Now I know its not realistic that home prices double again over such a short period of time but if you look at how much money our government is printing and how bad inflation has been over the last couple of years. Real Estate is a hedge against inflation and inflation is directly responsible for home prices going up so drastically.
Do I think home prices will double again over the next 10 years in these high appreciation markets?
I personally do believe they will.
Now let's take a look at your average home here in the Phoenix market and how you really get a huge monthly cashflow that can not only greatly increase your net worth but also give you the monthly cashflow you need to retire comfortably.
If you purchase a home for $550K it will typically rent for $2700 a month which doesn't get you even close to the 1% rule and is likely not going to cashflow. However I would still rather buy this property than the cheap property in the midwest that makes me 200-300/cashflow a month. In 15 years from now the 550K property in Phoenix could potentially be valued at over $1M. Your going to make some great cashflow once its paid off and it is still renting for $4K/month. Now what's that 80K property in the Midwest worth, I don't know but I'm guessing best case $100K to $120K.
My philosophy is this, while you are working and making a good income and you don't need the cashflow, you don't need to be financially free right away. I would rather increase my net worth and balance and then take the cashflow later on. It’s not like you will not have cashflow forever, it will cashflow in time. I'm not suggesting that you buy properties that are losing money monthly. What I am suggesting is find properties in high appreciation markets, rent them aggressive strategies such as Airbnb or Room by Room. To where your mortgage and utilities are covered by the rents. Then let the market do the work to greatly increase your net worth.
If you want do get financially free buy more homes than you need. If you think it will take 5 paid off homes to make you financially free. Do your best to acquire 10 of these homes. Let the market do the work. Once they’ve increased in value, sell half of them off and payoff the remaining mortgage on the 5 properties you keep
In conclusion I don't think you should not only be thinking about cashflow. You should also be thinking about increasing your net worth and balance sheet. We just talked about appreciation, but there is also so many other benefits to owning more expensive real estate. Depreciation being one of them. I do want to say this video was in relation to single family homes. When you are looking at larger multifamily properties. I do think it makes sense to go to these cheaper and higher cashflow markets because of scale and the ability to force appreciation when improving the properties cashflow.
