Yet another cashflow question (but slightly different than normal)

Rehabbing, Fix and Flip, Rental Properties
1

I know this subject has been beaten to death, but I’ve been looking through old posts and I haven’t seen these two issues addressed here:

  1. If you find a deal that cash flows well (using the 50% expenses, etc.), but the property values are declining steadily in that neighborhood, do you think twice about making the deal?

  2. If a deal will not cashflow at at least $100/month using 100% financing as your model, but will cashflow with, say, 10% or 20% down, is there any circumstance when it would make sense to still do the deal?

Thanks!

2

  1. If property prices are declining, obviously you shouldn’t buy at current market value - the money you will make in cashflow will probably be wiped out by your equity losses.

  2. You have to look at your cash-on-cash returns. If the property cashflows with 10% down or 20% down, you then have to ask yourself: How much does it cashflow? How much do I have to put down? What rate of return is that? Pre-tax? After-tax? How will this cash/cash return combine with appreciation/depreciation over time?

3
  1. If you find a property that will cash flow properly, then almost without exception, you will be buying it at a large discount to the current market value. Therefore, no, I’m not concerned about the decrease in price. If you’re in the rental business for the long term, your equity position at any given moment is irrelevant, as it doesn’t affect the cash flow. The key point here is to understand what is causing the prices to decrease and the likely affect on rental demand. For example, if the price decrease is being caused by the overall national economy (the recession), then that’s not much of a concern to me. On the other hand, if the price decrease is being caused by the biggest employer in town shutting their doors and a large percentage of people in your town are going to be without work, then I would be quite concerned.
2. If a deal will not cashflow at at least $100/month using 100% financing as your model, but will cashflow with, say, 10% or 20% down, is there any circumstance when it would make sense to still do the deal?

NO! Buying the cash flow with the downpayment does not change the quality of the deal. A bad deal is not made better by making a downpayment. If you think about it, even the worst deal will “cash flow” if you put enough down.

For example, let’s look at a hypothetical deal. It’s a three bedroom house. The monthly gross rents are $700 per month and the purchase price is $100,000.

Here’s how I see this deal:

Gross rents: $700 per month
Operating expenses: $350 per month
NOI: $350 per month
Mortgage ($100,000, 30 yr, 7%): $665

Monthly cash flow: $315 LOSS! OUCH!

I think we could all agree this is a terrible deal.

Now, let’s say that we had just inherited $60,000 and you decided to use that as a downpayment. Now the deal looks like this:

Gross rents: $700
Operating expenses: $350
NOI: $350
Mortgage ($40,000, 30 yr, 7%): $266

Cash flow: $84 per month

Is this really a better deal? Or is it the same pig dressed up with lipstick? You see, all we’ve really done is BUY the cash flow with our money. Worse yet, we’re pretending that there is no cost to this money (like the government does).

So, my answer is NO! If the property won’t cash flow when calculated with 100% financing, then I won’t even consider buying it.

Mike

4

thanks for the examples, Mike & vainvestor