When buying rentals - Is Cash flow your only consideration

Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes

When purchasing real estate as a rental. Most of us will spend a considerable amount of time to insure that it cash flows. Not so many years ago I ran into investors that paid much less attention to cash flow and their big consideration was appreciation.

In my opinion cash flow is important but other issues must be considered as well. You might be able to find a property that could cash flow very well for a couple of years and because of local market conditions become nearly worthless.

Seems to me their is more to consider than cash flow. Any thoughts?

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Jon Klaus

Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes

15y

I start with cash flow, but I also consider:

Location--is the property and area likely to grow and
appreciate? Is it relatively close to me?

Security--Is it a safe neighborhood?

Condition and age of property--Don't want a high maintenance property with a bunch of CapEx around the corner.

Marketability--Will it be a desirable rental for quality tenants? Will it be easy to sell when it's time?

Finance-able--Can I easily get financing and when I sell in the future, will my buyer be able to borrow on it?

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Jon Klaus
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
15y
I start with cash flow, but I also consider:

Location--is the property and area likely to grow and
appreciate? Is it relatively close to me?

Security--Is it a safe neighborhood?

Condition and age of property--Don't want a high maintenance property with a bunch of CapEx around the corner.

Marketability--Will it be a desirable rental for quality tenants? Will it be easy to sell when it's time?

Finance-able--Can I easily get financing and when I sell in the future, will my buyer be able to borrow on it?
8 Reply
Mark UpdegraffBusiness Member
Real Estate Broker · Rochester, NY · Member since 2010 · 1k+ posts · 689 votes
15y
Appreciation is a big part, but I don't sacrafice too much CF on speculation. I will commit equity to close tough deals easily and work through cash out after. Personally, I feel the time we're in now is a bottom if you buy correct. I don't see downside potential on any of my purchases to date. I bought well, and I bought cheap. If it gets any cheaper I'm buying ammo!
Podcast Guest on Show #112
Updegraff Group Realty4.746 Reviews
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1 Reply
Mitch Kronowit
SFR Investor · Orange County, CA · Member since 2009 · 1k+ posts · 1k+ votes
15y
I see wealth in appreciation, not $100/door. However, I still want to see that rental carry itself, i.e., produce enough cash-flow to cover it's expenses, so I'm not dragging around a boat anchor for several years waiting for its value to increase.
1 Reply
Bill Gulley
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Since you should never buy any property without an exit strategy, cash flow should never be the sole consideration. As Jon pointed out, I look first to cash flow covering the deal, only to the extent that it doesn'teat any hay, then to appreciation and financing by any qualified buyer (you can always seller finance a decent property). If it passes this RE acid test, then cash flow is considered further as a plus.

If you buy and hold for a few years, sell and move up, at the end you'll have equity in better properties that can be soldfor note income as opposed to being retired, yet working as a landlord!

After all, the ultimate goal is retirement! LOL
4 Reply
Bryan Hancock
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Cash flow is given far too much press on BP. I understand not wanting people to have an albatross around their neck, but there are great investments in every city that have negative cash flow for many years.

Cash flow chases many people out to secondary and tertiary markets to get the required yield to top their loan constant. Vacancy and ease of lease-up is much harder in these markets. Other factors like deferred maintenance can eat your lunch too.

Another thing to consider is that premium (low) capitalization rates are GOOD if your play is to buy, reposition, force appreciation, and sell. You get more bang for your buck if the cap rates are lower in these instances and the cash flow should be a much smaller consideration.

A lot depends on your goals and strategy. There is nothing wrong with making sure you cash flow, but it is only one of many important factors to take into account when making an investment.
3 Reply
J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
15y
I had so much to add...then I read the responses so far, and everything has been said...

So, this post is completely unnecessary...sorry for wasting your time having to read this...

:D
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2 Reply
Jon Klaus
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
15y
Originally posted by J Scott:
I had so much to add...then I read the responses so far, and everything has been said...
So, this post is completely unnecessary...sorry for wasting your time having to read this...

:D

Ha, you are providing an example to be emulated. When I see a topic with 10 or more posts, I rarely have anything substantial to add. Doesn't stop me from posting, though. :D

0 Reply
Bill Gulley
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Originally posted by J Scott:
I had so much to add...then I read the responses so far, and everything has been said...
So, this post is completely unnecessary...sorry for wasting your time having to read this...

:D

That's alright Jason, we have bad weather now and I'm staying inside today, so I have little else to occupy my time until it clears up. I didn't mean to be so windy in my post above and suck the wind out of any sails. Didn't mind reading it at all.....I'm bored anyway! :lol:

0 Reply
Mark UpdegraffBusiness Member
Real Estate Broker · Rochester, NY · Member since 2010 · 1k+ posts · 689 votes
15y
Originally posted by J Scott:
I had so much to add...then I read the responses so far, and everything has been said...
So, this post is completely unnecessary...sorry for wasting your time having to read this...

:D

In All things RE, the early bird gets the worm ;-)
Podcast Guest on Show #112
Updegraff Group Realty4.746 Reviews
Website View Page
0 Reply
Bryan Hancock
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Can we make this post a sticky? This can be the place where everyone posts when there is a new heated 50% rule post.
1 Reply
Cheryl C.
Investor · Reston, VA · Member since 2011 · 683 posts · 191 votes
15y
I was thinking about a similar post: CF vs appreciation. I agree with almost all the posts so far. Buy low in good areas with good tenants, where appreciation will out-perform. Sit back, relax and let the tenants buy houses for you. End game: staggered sell-off of free and clear property and taking back the paper.
2 Reply
Bryan Hancock
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
There is an EPIC cash flow versus appreciation post on BP Cheryl. It will take you half the day to read it, but it is well worth the time.
1 Reply
Cheryl C.
Investor · Reston, VA · Member since 2011 · 683 posts · 191 votes
15y
Thanks Bryan. I'll have to check it out. There are so many paths up the mountain, but the view from the top is still the same! (Little River Band).
0 Reply
Bryan Hancock
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Here it is Cheryl...

Circa '09 - Appreciation VS. Cash Flow - The Clash of The Titans...

Enjoy! And make sure to post on the thread.
0 Reply
Account Closed
Real Estate Investor · San Antonio, TX · Member since 2010 · 122 posts · 17 votes
15y
Originally posted by Financexaminer:
Since you should never buy any property without an exit strategy, cash flow should never be the sole consideration. As Jon pointed out, I look first to cash flow covering the deal, only to the extent that it doesn'teat any hay, then to appreciation and financing by any qualified buyer (you can always seller finance a decent property). If it passes this RE acid test, then cash flow is considered further as a plus.
If you buy and hold for a few years, sell and move up, at the end you'll have equity in better properties that can be soldfor note income as opposed to being retired, yet working as a landlord!

After all, the ultimate goal is retirement! LOL

Can you explain passing the RE acid test? I remember from my lending days that the acid test was Cash plus Marketable Securities divided by Total Current Liabilities. Similar to the current ratio but taking out inventory, accounts receivable and other current assets.

0 Reply
Bill Gulley
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
LOL, here's my chance to define a new aspect to RE investing....LOL!

No, it's my RE Acid Test, not related to current/liquid assets divided by current laibilities.

I could have called it the "it don't eat no hay" test.
If current or expected rents covers debt service, maintenance, taxes and insurance, along with carrying expenses, in other words it eats nothing, then it can be a buy for me (or anyone with a sence of adventure). If you hold such a property for 5 to 7 years and it is a decent building ina good location, is marketable and can be financed, there will likely be a profit to be had. Selling it with seller financing for anouther 5 years adds to the old bank account.

Cash flow is great, but I can easily make money in the long run with those properties passed over by investors insisting on using the 50% rule. Since I have never lost a dime in RE held, it's kinda hard to argue with that strategy.

Sorry to thow you a curve calling it the acid test, but it's a quick computation as to proceed with further analysis, that's all.
1 Reply
Sharad M.Pro Member
Carlsbad, CA · Member since 2010 · 1k+ posts · 1k+ votes
15y
I started a thread some time ago and I wrote this, and I think it applies here also:

From what I understand there are four ways to make money from a rental property:

1) Cash flow - Pretty straightforward. Total money you receive as income is more than total expenses.
2) Appreciation - Increase in the value of your property over the rate of inflation.
3) Equity buildup - This comes from paying off your mortgage principal balance each month. The lower the rate of interest on your loan, the more money you have going towards your principal, the better your equity build up will be.
4) Tax write off - You get to write off expenses for tax purposes like operating expenses, depreciation, etc. Tax write off is something that every rental property investor benefits from.

In my market, I am not relying much on appreciation. Though properties are a lot cheaper than they were a few years ago, but I am not being too optimistic for some decent appreciation. I plan to make my money from cash flow, equity buildup and tax write offs.

Each investor has individual goals and there is no right or wrong way to make money as long as we make money.
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0 Reply
Darin Wells
Real Estate Investor · Long Beach, CA · Member since 2009 · 6 posts · 2 votes
15y
Good luck...I agree with most of the other posts. Long term appreciation is part of my strategy.
0 Reply
Scott Karg
Real Estate Investor · Jarrettsville, MD · Member since 2010 · 76 posts · 12 votes
15y
I invest in section 8 rentals, so cash flow is king. I could care less about appreciation since very little, and sometimes none of my money is in my deals.
If I pay $50K today, and it cash flows at $500 a month and I sell it in 20 years, when it's paid off and I want to retire, even if the market is bad, and it STILL is worth $50K in the market, I still win.

Appreciation doesn't come into it at all for me, because of the type of investing I am doing.

My private home is a different story.
0 Reply
Mike McKinzie
Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
15y
Originally posted by Bryan Hancock:
Cash flow is given far too much press on BP.

I will differ from Bryan here and say that Cash flow is not given enough press here on BP. Sure, there are a few who chase the 2%, cheapy junk that rents for under $500 a month and requires a sidearm to collect rent.
BUT, the biggest failure of new investors is that the "revenue" is not larger than the "expense." They 'misjudged' the cash flow, either over estimating the rental income, under estimating the expenses, forgetting about vacancies or worst of all, getting the tenant from that bad place.

As for me, I am retired, so my cash flow is my groceries, utilities, etc....

As to the OP questions, Cash flow is NOT the ONLY consideration. For me, it is Cash Flow/Price. If I can get $1,500 a month on a $150,000 house in Texas, why would I spend $300,000 in California to get that same $1,500 a month? Sure, I could by 3 houses in areas like Indiana, Ohio, Tennessee, etc... for $50,000 each and get $3,000 a month rent. But I have seen those houses and that is not my strategy. Like in stocks, I don't buy tobacco company stocks, even if they give the highest return. I hate the Section 8 program and down to only 2 of them now. I had 10 at one point, so I am very familiar with the program. I tell all my managers, "No Pets, No DirecTV and No Section 8."

To me, the only time you don't consider cash flow at all is if you are wholesaling, flipping or buying a personal residence.

As a side note, I take my hat off to all you investors who do like those 2% rentals, you have more courage than I do.
3 Reply
Bryan Hancock
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
C'mon Mike...every 20th thread on BP is about cash flow and that is the sole determinant of the investment analysis in almost all of those threads. In fact...this is one of the few threads I have seen where someone was allowed to question whether or not cash flow is all that is important in the opening post without being ridiculed.
1 Reply
Jeff S.
Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes
15y
There is a publication in Portland called the Landlord Times and it cites a transaction by a Dallas based investment firm buying (in Portland Oregon) a Lloyd District midrise at a high 3% to a low 4% cap rate. They (Real Capital Analytics) project a 10% total annual return over the next 5 years.

Must be nice to have the bucks to be so optimistic. Looks like a bubble to me.
0 Reply
Bryan Hancock
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Those cap rates are nuts. Institutions constraining investment types in their strike zone is likely a cause of some of this lunacy. People buying stuff like that on behalf of their investors should by strung up. I guess if you are buying for cash and under perform it doesn't hurt you like buying with leverage in those scenarios.

Prudently banking on some appreciation in certain areas...especially if your plan is to force it after purchasing properties that are mismanaged is fine though. Many of the most successful investors I know in Austin made their fortunes on appreciation....not on the $100/month/door coming in.
0 Reply
Mike McKinzie
Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
15y
Bryan
I am not ridiculing anyone. But there is an old saying, "Appreciation is a paycheck and cash flow is a retirement."

Personally, I like both, and Appreciation will bring you MORE money, over all. But what do most of investors do with that money? They buy more cash flowing properties! ( Or become a HM lender)
1 Reply
Bryan Hancock
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
I like both too...the trouble is that it is hard to get both. Appreciation chasers normally drive cap rates down in areas with appreciation. Secondary and tertiary markets normally cash flow well (like your Altria stock), but offer little hope for appreciation.

Chasing *only* cash flow properties per the 50% rule of thumb causes one to look almost exclusively at those secondary and tertiary markets. That is fine if that fits with your goals, but many people don't plan to live off the $100/month/door. They do want some long-term appreciation with amortization and a nice little ancillary tax benefit. They may also want an inflation hedge too and choose to keep a bit more debt and thus "lose" $100/month or so. That $100/month may be cheap insurance if the rest of their portfolio is highly sensitive to inflation risk.

There is A LOT more to evaluating an investment than dividing the rents by two and capitalizing the "NOI." Try telling this to the 50% worshipers though...good luck.

I know we are on the same page here and we generally agree on these debates. Hopefully we can get others to see things the same way. I won't count on it though ;-)
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