Almost nothing is what it seems in real estate. This is nowhere more apparent than in income-producing real estate. The entire premise of rentals is not what it seems.
Now, I know that you don’t enjoy hearing the truth that contradicts with your perception any more than the next guy. But it is what it is — take it or leave it!
Why People Buy Rentals
When we talk about rentals, we primarily focus on the income, right? We are not wrong, but neither are we totally right.
Truly, we go “there” to solve a problem — to separate ourselves from the necessity to earn W2 wages. For some of us, it is the reality of our health, and others just don’t like their boss. One way or another, the focus behind generating passive income, which is only passive according to the IRS but not passive at all in reality, is to replace 1099 and W2 income.
This Conversation Could Go Two Ways
I could agree with you. Yes, diversified revenue streams afforded to us by the rentals we own are a good thing. The extreme flexibility of this income as it relates to taxation is also not a bad thing. Combined, yes — we can certainly achieve a measure of financial stability and freedom that are impossible by definition within the sphere of earned income.
On the other hand, I could also tell you that you are quite stupid thinking that cash flow will make you rich. Why? Because cash flow has never made anyone rich. Equity is the thing that makes us rich.
Let Me Put it in Terms You Can Understand
When you excitedly buy that asset that throws off $400/month of cash flow, what you’ve done, at best, is replaced $400/month of income that you have to earn at your job. OK, if you want to get specific as it relates to taxes, you’ve likely replaced $600/month of income.
But, tell me — are you, or anyone, getting rich off of $400/month of income? I know you’ve been hearing all about how cash flow is the ultimate objective, but when faced with the question, how do you answer — is $400/month of income making you rich?
Related: Why Cash Flow Beats Out Appreciation in Real Estate Any Day of the Week
And the Answer is…
Maybe. It depends on what you can sell this asset for when you are done doing what needs to be done. If you bought it for $200,000 and you will sell it for $200,000, then what you’ve got is not much of anything. However, if you’ve bought it for $200,000 and sell it for $250,000 four years later, then you might have something because considering the principal pay-off, you would be putting in your pocket about $80,000, and having that gives you some options.
Ask me how I know. 🙂
Cash flow is very important. Why? Partially because it gives you some freedom, but also because it helps you to hang onto the asset long enough to reposition it for sale. But understand — equity, just like cash flow, is bought at the front door. It may take time to materialize or liquify, but it should be there from day one. So, a bit less attention to cash flow and a bit more attention to the blend of cash flow and equity might be required at this time.
Hope this helps, guys.
What do YOU think? Do you focus on cash flow, equity or both?
Let me know your thoughts with a comment!