Low Cash Flow All That Bad Long Term?

General Real Estate Investing
1

Hello all,

Most of the board’s focus seems to be on high cash-flow. I understand that it’s probably because many are or want to be full-time investors. I initially started my research with a different approach. I was thinking more long term.

I like the idea of renters “buying” properties for me with little or none of my own money out-of-pocket. I may not get much positive cash-flow per property since I’d have mortgages, but figure that the properties will be paid-off around the time that I’d like to retire EARLY from my job. I would then have all that free equity to cash-in on, or I could continue to landlord (debt free) to supplement my retirement income. With this approach, I wouldn’t necessarily have to find super-terrific deals, just good deals.

If I pick-up a high cash-flow deal along the way, all the better. Maybe after getting my feet wet, I’ll really get the bug and want to take a different approach and become a full-time investor. Who knows?

But for now, is it really all that bad of a long-term strategy?

Thanks.

2

Who’s to say that any particular approach is wrong for you? If you are happy with the results, then that is all that matters. However, here are a few things to consider:

  1. Most people to are ‘letting the renters buy the property for them’ are really saying that the rent covers the mortgage payment, taxes, and insurance. Unfortunately, they have completely ommitted the operating expenses that go along with rental properties. When “unexpected” things come up, they simply pay them out of their own pocket, chalking it up to a one-of-a-kind event. They try to convince themselves that they are breaking even when in fact they are losing money. What they really have is a forced savings plan.

  2. There are an infinite number of hassles with rentals. Dealing with maintenance issues or maintaining the property yourself; dealing with managers or managing the property yourself; evicting tenants; dealing with the occassional lawsuit; dealing with occassional drug addicts or even drug dealers; dealing with extensive damage done by a tenant, etc are all hassles that landlords deal with in the real world. I don’t know about you, but I want to be paid for dealing with this nonsense.

  3. Why do only mediocre deals when you can do good deals? If you can find deals that will break even, how much more work is it to find a deal that will offer some cash flow? Given the choice between the two, I will take the cash flow deal every time.

Good Luck,

Mike

3

Cash flow is the name of the game with long term holdings. It’ll be what keeps you above shark infested water when a tenant sues you for nothing. It’ll help you deal with significant vacancies when a major employer moves out of town/ goes out of business. It’ll give you the possibily of buying other investment properties.

Owning long term holdings debt free is not usually the best way to handle your money (equity). Anyone who owns a calculator knows that you can have a better return by churning that equity over and over into the initial purchase of other properties. If you aren’t going to have an interest in purchasing more properties after your debt service is paid back, that’s a different story.

High cash flow vs. modest cash flow could mean the difference between waiting around to die (retire) in a Florida condo or a Florida mansion. More money is always better, long term and short term!

4

This is a good question.

The fact is there is a variety of ways to approach rental real estate. Rental properties come in a full spectrum from a financial perspective. On one end you have the high-end properties, that are cash flow negative, but might/could show a huge profit in appreciation. As an example, I see this in my area in SoCal, with triplexes that go from $1M+ a couple blocks from the beach, but have gross rents of $5k/mn. While this might be appropriate for someone, it is not more most investors as they will go bankrupt. On the other end of the spectrum is properties at the very low end that can be bough ultra-cheap, will generate lots of cash every month but will have have little or no appreication over the long haul. I see these in my town where I grew up. Houses that can be bought for $15-20k. Various styles can be right different financial and life situations. Personally, I have a full-time professional job and several side businesses and a family. While I spend a lot of time looking for the right deal, I don’t have time to chase down preforeclosure buy-outs, sheriffs sales, etc. I use property mgmt (4 different co for several dozen units/properties) becuase I have better things to do with my time than chase tenants for late fees ,etc.

My criteria is a property must be breakeven at when I buy it. Also, it must have some upside potential in rents. For properties that are far away, I look for combination of having “good mechanicals” (newer roof, prefer vinyl siding, reasonable kitchen condition), but perhaps needing cosemetic work that will allow for increase in rents. Big ticket capitial expenses can wipe out a lot of months of cash flow. Since I’ve been involved in rental real etstae for >8 yrs, I have a pretty good idea of what expenses will look like over the long haul. The #1 mistake people make is failing to figure actual expenses correctly. The often quoted number of 50% of gross rent is a bit high from my experience, but a very reasonable starting point for a new investor as you will make some mistakes along the way and push this will give you some buffer against getting upside down too badly

Lastly, the idea of hold forever and have it paid off is a nice concept but not so practical as mentioned it is not a great use of equity/capital. However, it has become much, much easier to get 2nds on NOO properties and I have done that on several properties I own to access the equity, but still the rents can service the debt.

5

Thanks to all for the insight. You make some strong and valid points. There are definetely many angles and statagies to consider when investing in real estate. I think I’ve blown a fuse or two over the past couple of weeks while reading through the threads on this forum! Great info and thanks to those with experience being willing to share. Please induldge a little more rambling…

I’ve always been interested in real estate. We rehabbed our first home and have had 3 other new homes built since (all our primary residences), where I was very involved and worked closely with the contractors to order materials, plan and cooridinate some of the work, etc. I enjoyed it all and have often considered spreading my wings a bit. For the fun of it and for our future.

I also have been somewhat inspired by my father-in-law, who over the past 20 years or so, purchased single-family homes, rehabbed them as needed, and rented them out. I believe that he always took a simple approach to it, and didn’t’ really consider some of the different tax advantages, leveraging opportunities, etc. In fact, he did many with cash, or paid them off as quickly as possible. He retired a couple of years ago and currently has about 12 median-priced, single-family homes (paid for) that he rents out. A very nice supplement to his retirement income. I realize that he probably could have more today had he worked some different angles, but I would guess that 90% of the population in our area would love to be in his position when they retire. It’s nice to be able to pick his brain and trust his experience as a landlord in our “small town” type area. He screens his tennants, and altough he does have some negative experiences to share (lost back rent, for example), overall, it’s done well for him. No lawsuits, no instances of thousands of dollars of damage, etc.

Now back to me: As my first rental investment, I’m currently considering a 3BR single-family-home. It needs some rehab, but we’re a family of do-it-yourselfers and costs would be kept to a minimum. I believe that I could purchase the home for approx. 20% below asking price. With as little as $5,000 down and after remodeling (new windows and siding, kitchen and bath, central A/C, cosmetics…), I estimate that I would have in the range of 30 - 45% equity in the home depending upon final appraisal. As for cash-flow, I figure about $1,500 per year accounting for mortgage, property taxes, insurance, and a maintenance fund allotment while allowing for 1 month per year vacancy. It’s not a lot and not the 50% rule that has been previously shared, but I’m comfortable with it. The renters would be paying off the mortgage and building my equity all while the home continues to appreciate. I know that I’ll have a few hassels along the way, but 15 or 20 years from now, I believe that I will be thinking that it was worth it. Multiply that by a few homes, and it gets even better.

After I get my feet wet, I know that there’s a good chance that my goals and approach could change. But for now, it just doesn’t seem like it’s all that bad of a strategy.

Thanks again for your comments.

6

Your approach is exactly what I’m doing now, and I’m very happy with the results so far. Buy properties that will rent for big numbers in your area (here I’m getting $1275 for a 2Br Townhouse) - this makes the possiblity of getting a low-life tennent minimal. I’m only 2 years into it, but my net worth is up more than if I just put money into a lame IRA or CD - good luck - do it.

7

I try to buy below value and have at least a 200 per month positive net cash flow from each property with none of my own money invested in the property for an infinite return.

8

I’ve always had the mind set that debt is bad. From listening to many of you, it sounds as though I may have to try to look at it differently.

So basically, many of you don’t mind how much debt that you have as long as you have good cash flow? That’s what you’re describing as good use of capital when you talk about not paying mortgages off, using equity in properties to leverage additional property purchases (borrow against them)? So you could have dozens of properties and be a ton in debt, but that’s fine as long as you have great cash-flow with the renters paying the debt burden?

I guess one of the concerns that I have to reconcile with is having the debt and payments to be responsible for. I suppose figuring in lost rent during initial calculations accounts for having to make some payments with cash reserves should a property or two be vacant. I’m blessed to have enough disposable income that I could swing some payments from my personal accounts should I need to, but I really want to consider my potential investments as separate and taking care of themselves. But gee, have all that debt out there…gee.

Currently for my first investment, I’m deciding between a single-family home and a duplex. While running my calculations, I’ve been figuring lost rent at 1 month per year for the single-family home and 2 months per year for both units in the duplex. Seems to be a safe and conservative approach. Is it enough?

I could really take the plunge and purchase both. Afterall, they are only 3 lots apart from each other! However, I’m thinking it might be better to get my feet wet with just one property and let it all “settle in”. If I could get over the debt concern, then both present a good opportunity. Both are fixer-uppers. After rehab, I estimate that I’d have 30 - 45% equity with the single-family and around 20 - 25% equity with the duplex. That’s with paying down only $5,000 on each at purchase.

Thanks again everyone. I appreciate the words of wisdom.

9

Land Baron,

I guess one of the concerns that I have to reconcile with is having the debt and payments to be responsible for. I suppose figuring in lost rent during initial calculations accounts for having to make some payments with cash reserves should a property or two be vacant. I'm blessed to have enough disposable income that I could swing some payments from my personal accounts should I need to, but I really want to consider my potential investments as separate and taking care of themselves. But gee, have all that debt out there.....gee.

Having debt is just part of running any business. Businesses don’t fail because of debt and the debt number is totally irrelevant. What matters is that you have the cash flow to service the debt and still have a profit. If you are having to come out of pocket for vacancies, you didn’t properly consider expenses when you bought the property. The operating expense figure at 45% to 50% INCLUDES everything including vacancy allowance. Obviously, when you only have a very few properties, you could be unlucky enough to have one of those BIG unexpected expenses such as a tenant from hell that does $10,000 worth of damage. These instances are very rare (I haven’t had one nearly that bad yet, but other experienced investors that I know have). If this happens and you only have a few properties, then you would probably have to come out of pocket. However, once you build your portfolio, then you should be all but immune to these expenses - they are already accounted for in the expense figures.

Currently for my first investment, I'm deciding between a single-family home and a duplex. While running my calculations, I've been figuring lost rent at 1 month per year for the single-family home and 2 months per year for both units in the duplex. Seems to be a safe and conservative approach. Is it enough?

It is an absolute waste of time and paper to try to list your expenses for any given property. It is impossible! Do you know whether a tenant will sue you this year? Do you know if a tenant will do $10,000 worth of damage this year? Do you know how many months your house will be vacant this year? Do you know how many evictions you will do this year? NO! Since there is no way to decide which expenses will apply to any given property, I just use 50% of gross rents for operating expenses. This is MUCH more accurate than trying to list individual expenses and will take into account all of the factors, even if they don’t occur this year.

I estimate that I'd have 30 - 45% equity with the single-family and around 20 - 25% equity with the duplex. That's with paying down only $5,000 on each at purchase.

I’d do the SFH if it would cash flow based on the equity. Personally, I do not buy properties with less than 30% equity. Also, why not do these deals with no money down? How many deals can you do if you must put down $5K at a pop?

Good Luck,

Mike

10

Thanks, propertymanager.

You answered a couple of questions that I just asked you over on another thread.

I think I could manage a mortgage with no money down, since I’d have the equity built-up after the rehab. Guess I still have to get out of the mentality that “debt is bad”.

I’d have to do some kind of financing at purchase to help with the rehab cost. I’ve considered setting-up a Home Equity Line Of Credit with my persoanl home to make the purchase and complete the rehab, then pay it back with a refinance after the rehab.

Thanks.

11

Land Baron,

Generally, I consider debt associated with my business to be good debt. Debt on silly things like cars, eating out, boats, toys, etc I consider bad debt. If you’re going to build a rental property business that will support your family, you should expect to have a debt of AT LEAST a couple of million dollars. As long as the cash flow is there, you’ll sleep just fine!

Mike