Buying a house for cash flow or equity?

Question

Hi,

My husband and I are looking at two homes.

One is in a bad area, but is cheap and would require some renovations (cleaning, paint, and a couple new windows, etc), but provide quick cash flow ($50,000 + $20,000 rehab) since I could easily be turned into a duplex. Each unit would rent for $650. The mortgage would probably be around $650. Instant $650 in our pocket! (leverage ~$25,000)

The other is in a nicer area and would not require renovations ($70,000). It's a 3BR one bath and would probably rent for $750. Which would only put about $100-$150 in our pocket a month, but the leverage would be ~$60,000.

The cost of either home would be the same. Which would be better to purchase? It's a matter of do we want money of course, but we can't seem to wrap our minds around it.

Is cash flow better than leverage? or is leverage better than cash flow? In which case would one be better than the other?

We currently own a home with $100,000 in equity and are thinking of taking a HELOC for our next investment property. I'm just giving this information so forum members could help answer this question better for us.

Thanks,

Jeri and Evan

Engelo Rumora · Answer

Hi Jeri,

I recently wrote a blog for Bigger Pockets about my perception on Cashflow vs Growth.

Feel free to check it out here:

I hope you find it useful.

Thanks and have a great day.

Chris Kennedy · Answer

Account Closed I see what you're getting at - basically should you invest in a lower value area for high cash flow, or a nicer area with lower cash flow?

When we started out we looked almost exclusively at cash flow, and we took properties in almost any location. While it worked okay for us, I now prefer the approach of purchasing in better locations, even if cash flow will be slightly less each month. There are two reasons for this: 1) I find that the management is much less time consuming on a property in a better location (tenants are better qualified financially, and generally have better job stability). 2) When you buy right in a good neighborhood, there is usually more room to increase rents by renovating a property. You can appeal to potential renters who have extra discretionary income and are willing to pay top dollar for a renovated property.

Having said that, you should definitely look closely at all of your operating expenses since there is much more than just a mortgage payment to handle when you operate a rental property. Make sure the rent will cover not only mortgage payment, but also insurance, taxes, management, ongoing expected repairs, etc. After all that, if the investment is good, you should still be putting money in your pocket. If you're not, then keep looking until you find one that works. The last thing you want is to have to come out of pocket every month to hold the rental property.

Hope that was helpful and good luck - this is the best business on the planet!

Arlen Chou · Answer

Hello @Jeri Dilts  you got some great comments from @Joe Villeneuve and @Chris Kennedy .  They have covered both the angles of the analysis side and the support side of the decision in front of you.  You definitely need to ask yourself the questions that Joe has posed to make a decision on any property.  But with the assumption that you have already gone through that exercise and you are asking the forum knowing the answers, then I believe you really need to look at what Chris is pointing out.

If the numbers work well on both the buildings and they both cash flow, but at different levels, then you really need to ask yourself how comfortable you are with the "bad area".  You will find that the definition of a "bad area" varies widely on the forum or person to person.  What I think is an "ok" neighborhood is a "bad area" for my wife.  However, in my experience I have found that the worse the neighborhood the more issues pop up.  These might be as simple as more turn over, to more complex "personality" issues with the people you will have as renters or even as neighbors.

It looks like you are just starting out in REI. You have decades to become successful! My suggestion is that you ease into the business and take on potentially less cash flow (safe) projects but also have less potential problems. That does not mean take on projects that you have to pay into waiting for appreciation!  Your comments above seem to indicate that that both properties will put money into your pockets on a monthly basis.

Don't underestimate the amount of headaches that you encounter, both financially and emotionally.  If stuff hits the fan the financial side can be repaired.  It is the emotional stress that sinks people in this industry and often times in their personal lives.  I like to buy the best deal in the best area I can afford.

Make sure to report back when you have made your decision.

Good luck on which ever house you buy!

-Arlen

Joe Villeneuve · Answer

This made my head spin.

The question of which is better, leverage or cash flow, is like asking which is better, a new car or a green lawn.  There's nothing to compare.  Let me explain why.

First, leverage is a tool that gets you better cash flow.  The question should be, which is better...leverage or all cash?

Second, cash flow is a result of all of your expenses, of which leverage could be one,  subtracted from the rent you get.  The question should be, which is better, cash flow or equity?

Now, the answers the above questions depend on your answer to this question:

"Why are you getting into real estate investing?...instant lump sums of cash from flipping, or monthly income from cash flow?

Also, as far as the two houses in question above are concerned, you need to have actual answers (not "about"), to the following questions before you can see which one fits best for you.

1 - Total cost including rehab2 - ARV (after repair value...these are the sales comps) for the two houses3 - Taxes4 - Insurance5 - Rents in the area (there are comps for this too)6 - Cost of a Property Manager (usually 10% of the rent)7 - How much, if any, of the rehab you can/will do?8 - Where is the financing coming from, and how much can you get...and what is the cost to you (terms)?9 - If you are flipping, how much profit do you want to make?10 - If you are holding (rental), how much cash flow do you want to make each month?

Buying a house for cash flow or equity?

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