Are you willing to invest in RE appreciation with 2 caveats?

[Matthew McNeil]

The context being today's market.

Assumption: the new asset would be in addition to your existing positive cash flowing portfolio.

Requirement: the new asset’s cashflow cannot be negative.  It must at least break even at zero - meaning the property is paying for its own expenses leaving you with zero cash flow/profits. 

Premise: future payout makes it worthwhile to forego current positive cashflow.

Thoughts?

[Matthew McNeil]

Originally posted by @Tony Kim:

Originally posted by @Matthew McNeil:

Originally posted by @Llewelyn A.:

@Ryan Spearman

@Russell Brazil

Russell puts it very nicely. I am in full agreement!

I like to say that the reality when it comes to Cash flow, the Characteristics of Cash Flow is NOT ABOUT THE INVESTMENT.... it's about the INVESTOR.

If I buy a property ALL Cash... then yes, it will cash flow.

If I buy a property with 100% financing, then NO, it will NOT cash flow.

So the characteristics of Cash Flow is really not on the Property. It's the INVESTOR that either cash flows or Not.

I do want to address something that seems to be a problem with most investors (if not all) who do not use Future Value formulas like the Internal Rate of Return (IRR) in a spreadsheet.

Many Investors don't really think of Cash Flow as anything but your Rents minus expenses.

HOWEVER, the reality is that Cash Flow is really something VERY BASIC. It is JUST a flow of cash. That's it.

There are some nuances to it, however. This is where it becomes a little tricky. If it is a flow of cash, that means it flows from one place to another.

We really need to pick a place of reference, then determine the DIRECTION of where the cash flows. THAT IS CASH FLOW.

I generally tell my students that the fundamental point of reference is your POCKETs.

Any money coming into your pockets is a POSITIVE cash flow.

Any money going out, is Negative.

I then mention that this is EASY to remember. If money comes into your pocket, how do you feel? POSITIVE!

If money is leaving your pockets, how do you feel? NEGATIVE!

Why is this important? Because every advanced formula you will use will need the direction of the flow of cash.

Take the IRR for instance.

In year ZERO, you are purchasing your Investment. If you paid $10k for the down payment and closing costs of the investment, then your very first cash flow is NEGATIVE $10k.

I think because there are so many investors that have not learned the sophistication of the calculations, they become emotionally against a NEGATIVE cash flow even though the very FIRST cash flow is NEGATIVE.

That's because they really only understand a definition of Cash Flow which does not actually involve the flow of cash! So yes, it makes sense that someone who doesn't understand the basics of cash flow to have an emotional reaction to it because they don't see the very first cash flow as negative.

Once you get the understanding of the basic of Cash Flow, you then understand the only way to really know your Investment is to sum up all the future cash flows.

So the very first Cash Flow is Negative.

The remaining cash flows before the Sale is either positive or negative, depending on the rents minus the expenses and the debt service.

And the LAST cash flow is almost ALWAYS positive unless you become underwater with your mortgage.

Given that, you can easily put together a list of cash flows and then the calculations of the IRR is so simple, it makes you wonder why the Majority of Investors really don't do it. The list of cash flows would look something like this:

Y0: -10,000 <-- Invested Capital

Y1: -1,200 <-- Rental Cash Flows (lost $100 per month)

Y2:    0 <-- Broke Even with Rental Cash flow

Y3: 1,200 <-- Finally! Making money on Rents minus expenses

Y4: 2,000 <-- Now we are rolling!

Y5:  3,000 + 12,000 <-- Rental Cash flow for Year 5 + Sales Proceeds

----------

IRR = 11% <-- RESPECTABLE RETURN !!!!

The only reason I believe they don't use IRR is that they don't really understand cash flow and how to use it in formulas.

It really amazes me that these future cash flows are completely ignored by the general investing population.

Somehow I really have hope that eventually, all Investors will start to get some knowledge so that they can really get a vision on the future of their Investments.

I would say that these Future Value Calculations are a prominent reason why I have been so successful. I think everyone should consider it.

LLewelyn, can you point me to a IRR calculator or Xcel template that you've found useful.

 Try this one

https://docs.google.com/spreadsheets/d/1O49BE9kdKlyLOWrEoA9U2ztbCnSLFKg2pKk7XWfJ3dQ/edit?usp=sharing

 Thanks Tony.  I'll give it a look.  

[Llewelyn A.]

@Matthew McNeil

The BEST books on Cash Flow which tells you exactly what it is, how to use it, and why you should really study the Internal Rate of Return (IRR) and it's derivatives, is this one: What Every Real Estate Investor Needs to Know About Cash Flow..

However, you will need to understand Excel Functions and how general spreadsheets work.

The other issue is that the Author, Frank Gallinelli, probably makes the assumption that most of the readers of this book have at least High School Math.

I will tell you from my own teaching of Adults, there is NO WAY the average American Adult, including Doctors, Lawyers, etc. remembers Math to the extent of High School.

Yes, you don't need to know Pre-Calc, but people get so confused with Math. I would say the majority of people who try to invest when they do not have a degree in a Financial field will do two things.... 1) look at the book and get very sleepy and 2) Tell themselves that they don't need these "complicated" calculations.

The reality is that when you speak with the highly trained Pros, they ONLY speak about the IRR and other derivatives of it.

It doesn't matter what you invest, the professionals who Invest need to know it.

In some cases, heavy calculus is used for trading, such as in the Quant professions.

This book gives you all the math you need which probably goes only the the extent of intermediate school.... say, 7th Grade, but many adults are very intimidated. They just won't admit it. But admitting it is the BEST you can do for yourself as an Investor. Because then you know that you have a disadvantage to overcome. When you overcome it, then you will gain a vision that only those in the field who knows it well has.

I also want to point out that when you do your future projections of Cash Flow, it makes you think of the Future. If you don't think of the future, then you are not understanding either the opportunities or the potential road blocks ahead of you.

I consider every Investment to be an Investment Vehicle. If your eyes are focused on the Side View and you NEVER look through the windshield, you crash your car.

The Side View is the Cash Flow NOW. It is your Cash on Cash Return, your calculation of today. It is what you see through the side window, which is the things that are right there.

The Rear View is also a bad place to focus your eyes. It tells you a lot about what has already happened. BUT again..... if you never look through the wind shield, what do you think will happen to your Investment Vehicle? The rear view is a good thing to do once in a while because you need to see the police that may be tailing you waiting for you to start speeding! haha... but you should NOT spend too long doing it.

Where should you really focus your attention?! You need to be looking almost 90% THROUGH THE WINDSHIELD. You need to see clearly the warning signs, the roadblocks and the signs that will tell you to stop because the bridge is out. Don't drive your Investment Vehicle into a hole, see clearly where to steer it to avoid the potential pit falls.

The IRR helps you look through the Wind Shield. Economics help you as well. Putting together Economics and the IRR as well as understanding your locality, your neighborhood, the City and the Macro Economics, you will get a clear understanding.

Anyway, I'm sure the reader gets it... I THINK! haha.

[Matthew McNeil]

Originally posted by @Llewelyn A.:

@Matthew McNeil

The BEST books on Cash Flow which tells you exactly what it is, how to use it, and why you should really study the Internal Rate of Return (IRR) and it's derivatives, is this one: What Every Real Estate Investor Needs to Know About Cash Flow..

However, you will need to understand Excel Functions and how general spreadsheets work.

The other issue is that the Author, Frank Gallinelli, probably makes the assumption that most of the readers of this book have at least High School Math.

I will tell you from my own teaching of Adults, there is NO WAY the average American Adult, including Doctors, Lawyers, etc. remembers Math to the extent of High School.

Yes, you don't need to know Pre-Calc, but people get so confused with Math. I would say the majority of people who try to invest when they do not have a degree in a Financial field will do two things.... 1) look at the book and get very sleepy and 2) Tell themselves that they don't need these "complicated" calculations.

The reality is that when you speak with the highly trained Pros, they ONLY speak about the IRR and other derivatives of it.

It doesn't matter what you invest, the professionals who Invest need to know it.

In some cases, heavy calculus is used for trading, such as in the Quant professions.

This book gives you all the math you need which probably goes only the the extent of intermediate school.... say, 7th Grade, but many adults are very intimidated. They just won't admit it. But admitting it is the BEST you can do for yourself as an Investor. Because then you know that you have a disadvantage to overcome. When you overcome it, then you will gain a vision that only those in the field who knows it well has.

I also want to point out that when you do your future projections of Cash Flow, it makes you think of the Future. If you don't think of the future, then you are not understanding either the opportunities or the potential road blocks ahead of you.

I consider every Investment to be an Investment Vehicle. If your eyes are focused on the Side View and you NEVER look through the windshield, you crash your car.

The Side View is the Cash Flow NOW. It is your Cash on Cash Return, your calculation of today. It is what you see through the side window, which is the things that are right there.

The Rear View is also a bad place to focus your eyes. It tells you a lot about what has already happened. BUT again..... if you never look through the wind shield, what do you think will happen to your Investment Vehicle? The rear view is a good thing to do once in a while because you need to see the police that may be tailing you waiting for you to start speeding! haha... but you should NOT spend too long doing it.

Where should you really focus your attention?! You need to be looking almost 90% THROUGH THE WINDSHIELD. You need to see clearly the warning signs, the roadblocks and the signs that will tell you to stop because the bridge is out. Don't drive your Investment Vehicle into a hole, see clearly where to steer it to avoid the potential pit falls.

The IRR helps you look through the Wind Shield. Economics help you as well. Putting together Economics and the IRR as well as understanding your locality, your neighborhood, the City and the Macro Economics, you will get a clear understanding.

Anyway, I'm sure the reader gets it... I THINK! haha.

Thanks Llewelyn. I was first introduced to IRR when I owned a banana plantation under contract for exporting to SE Asia and the Middle East. We were seeking to fund an expansion farm and the comptrollers wanted to make sure the IRRs were calculated correctly for the investors. But I've always let the accountants work out those figures until I started investing in real estate 10 years ago. I see the validity of IRR and will work on my numbers to determine what it is for each asset.

[Kevin Taney]

@Matthew McNeil To add to the abundance of good information in this thread, @Brandon Turner and @David Greene touch on this topic in Episode 290 of the BP Podcast. They refer to it as “stacking.” There is a way to build net worth by buying one house a year on 15yr mortgage for 15 years. Even just breaking even, by the 15th year the first house is paid for, then every year after that! As many have previously stated, it is determined by your goals and dependent on the numbers. Brandon and David suggest this for people who don’t really want to quit their job but want to invest and build net worth. I hope this helps!

[Matthew McNeil]

Originally posted by @Russell Brazil:

Originally posted by @Ryan Spearman:

@Russell Brazil So that brings us to the actual definition of cash flow. The mortgage on the property is generally what tips a property from having positive cash flow to negative cash flow.

Do you consider a property to be negatively cashflowing if the “negative” portion is actually paying principal? A property may be negative on a 15 year loan but break even or even be positive on a 30 year loan, and still making the same profit.

If someone else is paying down my loan I am happy

 All investing is a risk based activity in which you allocate capital to achieve a certain return for the risk profile that the investor finds acceptable. Using leverage to buy an asset whether real estate or a stock or a business adds more risk to the equation. 

It is most peoples inability to properly assess risk that leads to a misunderstanding of how to evaluate and properly understand an investment. An A class asset is an inherently less risky asset than a D class asset. An A class asset however might not cash flow when leveraged at an 80% ltv while a D class asset likely will. 

The person prone to investing in the D class asset might then look at a person investing in an A class asset and believe they are speculating as opposed to investing, but really its not being fully informed on risk assessment in investing that leads one to draw that conclusion.

Having a 15 year vs a 30 year note on a property doesnt change the underlying risk of the asset. It will change the return you receive on your capital, as leveraging generally increases your return, but it also increases your risk.

Russell, I believe you’ve summed it up best when you wrote; “The person prone to investing in the D class asset might then look at a person investing in an A class asset and believe they are speculating as opposed to investing.”

I’ll wander out on a limb here (knowing someone might saw it off) and oppose the assertion of the Class D investor.  If the Class D investor believes the Class A investor is speculating on appreciation because cashflow is deferred, then I’ll counter that a Class A investor (like myself) believes the Class D investor is speculating on cashflow. 

OK, maybe that's arguable, but what about the asset behind that cashflow?  Is it appreciating like a Class A?  As you wrote; “An A class asset is an inherently less risky asset than a D class asset...”

The intent of my initial post was to counteract the mainline philosophy purported by many BP members to never invest in appreciation.  In fairness, we all agree that only a foolish person would invest in appreciation for the sake of investing in appreciation only.  

But a Class A buy and hold investor understands that investing can also involve positioning, and "positioning" may require deferring cashflow knowing the asset (based on the market) will appreciate over time.