Is cash flow REALLY king?

Well, as with all good economics questions… IT DEPENDS!

Cash flow is what allows your business to survive, thrive, and grow. And that is what makes it king, but there are other things that real estate brings that need to be looked at as well. I wanted to explain a few of them as I understand them and their need to be included in the consideration of investing.

Tax benefits and depreciation.

Not everyone understands how real estate can be tax free investing, and even pay some of your taxes from other income.

Example from my taxes this year.

Invest 300k in a 1.5 million dollar investment several years ago. The investment is just now starting to break even on cash flow. This has been very disappointing for us, but was out of our control due to tax law changes in our city. However, with it just breaking even cash flow wise this year, our tax returns from this investment shows a net income of -77k in income due to a lot of depreciation on the books. Depending on your tax bracket, this means that while the investment broke even cashwise, it paid for about 20k of my taxes from other income ( the net income flows through and reduces my taxable income by 77k ). This is very close to the same thing as cash return, since I would be out the cash to pay the taxes otherwise. This is a roughly 7% return on my investment just in tax benifits.

I think there is confusion on why people with high income buy property for a “loss”.
As the above example shows, you can easily have “passive loss”, or a negative net income on your taxes, and yet still be making cash flow on a property. If you have no other income for the loss to offset, then it doesn’t help you much other than to sheild your cash flow from the investment itself from taxes.

Appreciation

I have a hard time swallowing the idea that appreciation is nice if it happens, but not something to count on or even consider. Appreciation should not be the deciding factor in my opinion, but history shows that it should always be there as a return to ownership over time if the cash flow is there so that you can maintain the ownership. If you look at most investors that have been in the business a long time, I find that they have lived off cash flow, but gotten wealthy off of appreciation and their ability to hold property as it goes up in value.

Just a few thoughts to think about at tax time.

DB

I think there is confusion on why people with high income buy property for a “loss”. As the above example shows, you can easily have “passive loss”, or a negative net income on your taxes, and yet still be making cash flow on a property.

I don’t think the confusion stems from buying a positive cash flow property that generates a net passive loss. My bewilderment is why a high income investor would buy a negative cash flow property for an even bigger tax loss. If this investor can not make his tax savings exceed his $200 to $300 monthly negative cash flow, why does he consider this a good investment? A short term holding in a period of rampant inflation I get, but we don’t have that today.

Actually many large companies and ever serious investors in many fields will buy many negative cashflowing businesses to ofset taxes due to the fact that over time, the asset can be more valuable broken down or through redevelopement.
There is a very valid point here being made. In some markets before the real estate market got hot, like SoFl, buying for cashflow was almost impossible. So investors bought negative cashflow, even with 30% downpayments but knew they would have 5-8% appreciation and in 3-5yrs can sell and make a nice profit while declaring a loss or breakeven yrly thru the rental income. I think you can carry a loss for 3 yrs, so say your losing $20K a yr for 3 yrs, that is $60K and then sell for $100K profit, I think you will only need to claim 40K in income that tax yr. (I am not a CPA but think it works that way-- I am sure someone can clarify that)

Do I buy negative cashflow deals? Yes I did during the boom b/c I was able to flip for profits still ,especially c ondo conversions. It made sense business and tax wise. These type of deals need to be put on paper so you can see them entirely.