Why Cash Flow is Vital When Investing in Low-Income Areas

Let’s face it, owning long-term (or buy and hold) rental properties is not for the faint of heart, especially if you decide to manage them yourself.

There are many things you need to know about, such as contract law, negotiation skills, state specific landlord-tenant laws, and even local ordinances. And this doesn’t even delve into deeper topics, such as the most efficient ways to deal with tenant turnover. The list goes on.

Cash Flow is King

If you do decide to be a landlord, whether you want to turn things over to a professional property manager or not, I strongly suggest that you invest in real estate that positively cash flows before taxes.

First, let’s make sure the rent is at least higher than the PITI (principal, interest, taxes, and insurance) at a bare minimum. Some folks like to include a percentage for vacancy, maintenance, or management fees as well. I agree, but at the very least, gross rent should be several hundred dollars higher per month than the mortgage payments. So far, so good — right?

Low-Income Areas

This is where things can get tough. Many times, the only areas that cash flow are areas that may be the tougher parts of town, either with higher crime rates, no jobs, or possibly poorer schools. The trick for me was to invest in areas on the brink of change.

Usually, I search through all the areas in my county (or the next county over) that fit in my price range. My goal was usually to be all in — purchase price, closing cost, repairs, and cost of capital — at 65% of the ARV (after repair value).

At that point, once I moved a tenant in, my goal was to cash flow a few hundred dollars per month after I got all my capital back through the refinance.

Rinse and Repeat

Once I got all my capital back to return to my private (or hard money) lender, I’d go out and find another property just like it and repeat the same process.

The reason I liked areas that were on the brink of change was because the property value hadn’t fallen yet, but the perception was that the neighborhood was about to decline. I’d go in and steal a good deal, fix it up nicely, still get a good appraisal on the refinance, and then cash flow my way into wealth.

An old-time investor had told me this strategy, and I just did what he said, but it worked.

After 30 years of using this strategy, here’s what happened. I’ve grown my equity by a few million dollars, my tenants have paid down many of my properties, I’ve written off an awful lot of expenses (thus saving a lot of money in taxes), and I’ve borrowed out a lot of my equity to do notes and private money deals for fellow rehabbers.

Appreciation

As for appreciation, I haven’t done spectacularly, but I’ve done OK. I’ve been through several up and down cycles. When values are down, I hold and cash flow (and sometimes even pay down properties). When the values are up, I sell some (or refinance some equity out) to cash flow in other deals. Often I’ll sell in areas where I feel it’s now time to get out and perhaps move my capital into a more valuable piece of real estate. This is especially since today I’m more financially well-off and don’t necessarily need more income.

Unfortunately, more is not always better as a real estate investor. Today, I’m not really looking for more aggravation in my life, especially when it comes to managing more properties, whether they cash flow or not. In fact, don’t tell my property manager, but I don’t even like it when she calls me. It’s not like she’s calling to say happy birthday; it’s usually about a problem.

Today my strategy is more about cash flowing in other ways, and for me that’s usually through lending backed by real estate as opposed to in real estate.

So, let me ask my fellow BP folks: How do you like to cash flow and what’s your strategy?

Let me know with a comment!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.