Cashflow vs. Net Worth

[Kyle Lush]

Hi BP friends. I'm an aspiring real estate investor and I have a question regarding cashflow vs net worth when starting out.

I've made an introduction thread before but once again my situation is as follows. I am 30 years old and currently work a full time job as an engineer. I am going to invest in real estate in order to obtain the passive income needed to quit my full time job and free up my life to spend doing the things that I love while continuing to invest. I will do this by investing in large multifamily properties. I don't know how I will get started in large multifamily properties but I have several ideas (partnerships, starting with smaller properties and scaling, doing some flips to raise capital, etc.). 

I am currently paying off my remaining student loan debt which I hope to have gone in September. My only other debt that I have is my home, which I bought last November, before really having an investor mindset, using a USDA Rural Development loan and 0% down. The debt that I owe on my house makes it so that I have a negative net worth, which will still be negative, even after paying off my student loan debt.

I'm wondering if I should be concerned about this. Should I concentrate on bringing my net worth up through saving or investing using other, unleveraged means for a few years before investing in real estate? What I am thinking about is the fact that if I start investing in properties using 20% down.... or anything below 50% down it will not help my net worth as there will be more debt than there is equity. This will get better with time because of loan paydown and appreciation but then if you were to pull cash out in order to finance another property again with 20 or 25% down it would hurt your net worth. I'm wondering how I should approach this.

Not worry about my net worth and just focus on getting that cashflow started and scaling as quickly as possible?

Start off only going into deals with at least 50% down or 50% of ARV?

Save and invest through other means until my net worth is positive and then ensure that it stays that way?

I've searched online and read various articles and blogs about cashflow and appreciation. Much of what I have found says that cashflow is king and that net worth just looks good on paper as cashflow really enables you to live and invest now and banks look more at cashflow and debt/income than they do your net worth (my current debt/income is 14.9%). I agree with all of this and my main goal is really to build passive income as opposed to just a huge net worth but isn't a negative net worth something that needs to be addressed and thought about? Seems almost like an indicator that my life as a whole is "overleveraged" and it should at least be kept positive. Please let me know your thoughts and opinions!

Thanks

[Dan Schwartz]

@Kyle Lush good introspection here. I'll start with this:

"anything below 50% down it will not help my net worth as there will be more debt than there is equity."

This should not be true.

If you $20,000 in cash and nothing else in your financial life, you have +$20,000 net worth.

If you decide to convert that cash - start to use that word, "convert," when moving assets between classes, like from cash to stocks or stocks to real estate - into the down payment on a $100,000 house, you will still have +$20,000 net worth!*

You now have
$100,000 asset (investment property)
$ 0 cash
($80,000) liability (mortgage)
= +$20,000 net worth

* note, there is friction in any transaction, and in the case of buying a house it includes the cost of purchase, cost of loan if needed, etc. One generally winds up with a lower net worth after a purchase, due to these costs. Some will argue that if you buy "below market," you have "built-in equity," and thus begins some accounting practices debates. I'm trying to keep it simple.

Hopefully that clears up a misconception regarding net worth. Whether or not you choose to leverage your investments or not is up to you. The gamut of investment strategies runs from 0% leverage to 100% leverage and beyond. Many proponents of all types can be found on BP, and might even chime in here.

Good luck!