If you’ve been investing for the long run, it’s almost axiomatic you’ve read a buncha how-to books, watched countless webinars and/or videos on the subject. Most of ’em, at least from where I sit, give solid advice, if considered in a vacuum. For example, the counsel encouraging cash flow is a no-brainer, right? Not so fast, QuickDraw breath. If you’re 39 years old with 10-25 years to retirement, what on earth does a lotta cash flow do ya now? You’ve already demonstrated you’re flush simply by having enough money to buy investment properties in the first place. So clearly you’re not hurtin’ for cash flow. What you are hurtin’ for is reliable retirement cash flow, which, considering most Americans’ current status — if between the ages of 40 and 55 — looks mediocre on a good day. Assuming the investor is consistently acquiring properties in blue chip locations, the most common error far and away is their plan’s chronology re: Cash Flow.
BawldGuy Axiom: Cash flow is nothing but a yield on invested capital. Duh The larger the capital invested, the larger the yield in terms of dollars. X% yield is X% yield whether it’s on $100,000 or $1,000,000. The only difference is that the guy with the latter number gets 10 times the income. Grow your capital as quickly and as SAFELY as you can. The investor who reaches retirement with the biggest pile of gold — read: capital/equity — wins, in terms of dollars per month cash flow in retirement.
Here’s the problem in a nutshell — To the extent you go for cash flow you hinder capital growth — and vice versa.
That is a law of what I’ve come to call the physics of real estate investing. For example, even though a particular property(s) can be had, with some reasonable cash flow, for 20-25% down, the cash flow guy will insist on putting more down, sometimes even opting for payin’ all cash. Is there anything inherently wrong with that approach? Not a thing. But consider two investors with differing approaches with the same initial $200,000 in capital.
John and Bill are both 45, and have decided to buy in the same neighborhood. John acquires five properties at 20% down plus closing costs at $175,000 apiece. They pay for themselves with some cash flow. John now owns $875,000 in property. Bill, opting for much more cash flow now, purchased three of ’em at the same price, opting to put 35% down plus closing costs. His total adds up to $525,000. Depending upon total cash flow, plus any additional cash they can contribute from the family budget to be used to eliminate these loans, they can both end up in the next 8-15 years with all their rentals free ‘n clear. John will end up with roughly 65% more cash flow than Bill — when it matters — which is at retirement. John’s additional risk was real, as he’d borrowed more money than Bill. ‘Course, after 1-3 years of applying cash flow and excess (whatever the heck THAT is) family cash, John’s LTV (Loan To Value) is easily down to below 70% anyway. Maybe lower.
Bill has opted for significantly less ultimate retirement cash flow due to his decision to force higher cash flow when he had no use for it. No use for it?! Exactly — at 45 most folks are makin’ more at their job than ever, and will tell you, based upon their knowledge of the situation and industry, that they expect to be makin’ more at 55. This means they need their savings to grow quickly and safely. It doesn’t mean they need to sacrifice capital growth on the altar of current cash flow. Wait a sec, and let me rephrase that thought in a more meaningful way.
Bill has chosen to sacrifice future income — at retirement — in return for generating cash flow today — that he, by his own admission, doesn’t need.
Timing matters — Big Time
We can slice ‘n dice this any way ya want. There are some who simply aren’t comfortable usin’ down payments less than 35-50%. Some are uncomfortable with even the idea of acquiring debt. Again, nothin’ wrong with that school of thought. It’s about comfort zone, remember? Just understand that your comfort zone may be challenged in retirement when your cash flow isn’t what you’d imagined. The timing of capital growth and cash flow is pivotal when it comes to planning for retirement income. The laws governing the physics of real estate investment don’t have feelings — they just are. They work every time they’re tried.
And they will not be mocked.
Photo: Alan Cleaver