High Property Prices. Cash Flow vs. Equity

[Jenny Duclair]

Four times so far I've been told to focus on cash flow rather than purchase price. This is by two long term buy and hold investors, a short term dabbler and a realtor trying to sell me a property.  Because I'm going in owner occupied my cash flow would be minimum $400 (this is before any due diligence and whatever cap ex that may turn up-but I'd renegotiate purchase price in that instance). Regardless of the $400 per month cash flow the purchase price would be 75k per 2/1 unit on most of these West Palm beach MF properties. When I look through sale records I see these property owners are not only looking to pay off existing mortgages but to walk away with cash in hand. I don't begrudge them, but I think The market is peaking and if I buy now, regardless of cash flow, *I'll* be the one under water in four years. Buy and hold investors in metro cities, what say you? Should I wait until prices drop? Or just focus on cash flow?

[JD Martin]

Well, it depends on how long you intend to hold. If you hold forever, and your equation always cash flows positive, you're never underwater. In other words, if you have no plans on trying to pull your equity from the property, it makes little difference if you paid 50 bucks or 5 million bucks on the property, so long as it produces a commensurate level of return. 

Consider in some Utopia that you bought stock in a company that paid a fixed dollar dividend of $1,000 every year, regardless of the value of the stock. If you bought the stock for $10,000 and planned to hold it until you were dead, it really wouldn't matter if it went from $10,000 in value to $1,000 in value and then up to $100,000 in value - you'd still be making the same $1,000 every year. 

If pulling your equity is important as part of a strategy of trading up, or increasing your portfolio, or similar, then it is very important how much you buy in. If you buy in at $150k and net a $10k return every year, and 5 years from now you want to sell and have to sell for $100k, your net return for 5 years is 0%. Not a very good deal.