CASH FLOW: Why you have been analyzing your deals all wrong.

[Andrew Postell]

This might be my most controversial post ever…that is, until you see what I have to say.

And what I’m talking about is cash flow – and you’ve been lied to about it. Ok, maybe not LIED about it. But it has been GROSSLY exaggerated. I’ve seen the same articles you have. The same books. The same videos. “Just sit back and relax! Collect mailbox money!” That might be possible for someone with significant means but for the average real estate investor this isn’t realistic. Especially in this environment. Real estate is difficult, it is not a “get-rich-quick-scheme” but if you do participate in it then real estate will be one of the best investments you can make. As long as you have the right expectations.

Cash flow is NOT the most important piece of the equation. And I’m going to show you why. First, some historical perspective.

If you have been investing in the past 10 years the current environment is VERY foreign to you. But for those of us been doing this for a while, we’ve seen it before. And if you are “newer” then get used to this. This occurs every 8-12 years. If you learn from this one, you’ll be better prepared for the next one. This is where we make our money. Pre-Housing Crises (pre-2008) interest rates for investment properties were 6.5%-7%. Cashflow wasn’t even part of the discussion. Frankly, neither was the interest rate! Pre-9/11 rates were 7%-8% for investment properties. Everyone knew the score. If you wanted to be a full time investor then you flipped properties. That’s what you did. But if you kept a couple of properties a year, then in the long run you would be very wealthy. Only in the past few years has “cash flow” even been a strategy. But now that prices are so high, interest rates are high, insurance premiums have shot through the roof, etc. many investors are wondering how to make this work. I’ve had people tell me “I’m only buying a property if I cash flow $500 per month”. Ok….I guess I’ll see you in about 5 years? Meanwhile, the rest of us are becoming millionaires while you wait on the sidelines. And at no fault of their own – cashflow is what they were SOLD on.

Here's what I want you to understand about “buy and hold” residential real estate:

• Let’s use a single family home with a property value of $300,000
• Let’s use an initial loan amount of $240,000
• Let’s use an interest rate of 7.25%
• And I’m going to give you $150 of cash flow per month
• Use a 5% appreciation amount for your property

Let’s see what happens after 5 years:

After 5 years…

• $150 of cash flow per month = $9,000
• Your mortgage has been paid down to $227,000 = $13,000
• Your property is now worth $382,000 = $82,000

So that’s $9,000 of cash flow, $13,000 of principle buy down, and $82,000 of appreciation. We make money in 3 ways with “buy and hold” properties…and cash flow is the smallest piece!

Will you cash flow in this environment currently? No, you will not. At least, I want that to be your expectation. Make your offer a little lower because of it. Also, don’t forget you will increase your rents in year 2, year 3, year 4, etc. So you WILL cashflow eventually but go into the property expecting not to cashflow now. And then you are still going to make $95,000 on a property. Remember Brandon Turner’s article on “How to Make $100,000 per year” – you can read it HERE.  Don't forget about it.  

If you analyze properties on their "Year 1 Cash Flow" then you are going to miss the boat.  Buyer's have all the power now.  It's not your fault someone is asking too much for their property!  Just adjust your numbers on your offer to account for the difference.  Don't miss out on the opportunity that's in front of you.

Thanks for reading!