Cash flow is not King Part 2

[Arn Cenedella]

I often find myself as a contrarian in the multifamily space. 
There are certain ideas - let’s call them conventional wisdom that are repeated ad nauseam - as if they are handed down from above as TRUTH.

Cash flow is KING is one of them.

Cash flow is important in that is is necessary for a property to be “self supporting”. But once that level is reached, in my mind, equity growth and an increase in net worth should be the goal.

I’ll share a recent acquisition to illustrate the point.
If I had chased cash flow and financed accordingly, the deal would now be in trouble. But since I didn’t and used my own judgement I have a deal that is killing it and will for another 8 years.

12 unit 1994 property Solid condition not requiring lots of cap ex. Spring 2022 purchase date.

Existing rents about $1000. Market rent $1300.

$1.3M purchase price

Due to low existing rents, LTV was constrained.

My loan choices were:

1. 80% LTV, 6% bridge debt 2 year term interest only payments

2. 65% LTV 3.85% fixed rate debt 10 year term 20 year amortization

If cash flow was my goal and juicing the IRR my secondary goal, option 1 would have been the choice. The cash flow is king folks would be happy.

I chose option 2.

Interest rates have exploded and my investors and I have another EIGHT YEARS of sub 4% debt.

The property produces some cash flow. And over the 10 years, we will have paid (really the tenants would have paid) the loan balance down by about $350,000.

That’s principal paydown on average of $35,000 a year that’s almost $3,000 a month.

Question: Would you rather have an extra $1,000 a month cash flow and NO principal paydown or $1,000 a month less cash flow but pay that loan down $3,000 a month?

I believe $3,000 is more than $1,000 and even considering the time value of money, $350,000 more in 10 years is worth more than an extra $1,000 a month for 10 years.

Honestly, if you bought this deal, and took option 1 following the mantra of cash flow as king, where would you find yourself now?

You would have a marginal deal on your hands and be forced to refinance into a 7% loan and pay closing costs all over again. But hey, you got a little cash flow along the way. 

I chose to ignore the mantra the conventional wisdom and made a solid choice to choose long term wealth over short term cash flow.

Investors who turned their nose up at the deal with 10 year fixed debt 20 year amortization are now kicking themselves and many many find themselves in some failed value add deal with the lender knocking on their door.

I choose long term fixed rate debt over cash flow and my investors and I will reap the benefits from this decision. It’s solid. It’s gold.

Cash flow isn’t always KING.

[Allan C.]

@Arn Cenedella In 80s and 90s people had less accessibility to excel and other programs that could easily calculate IRR, thus they likely included debt pay down as cash flow out of simplicity.

Today anyone can calculate discounted cash flow, so it’s incorrect to factor debt pay down as cash flow…. unless you discount it and net the exit cost (cash out refi or disposition).

One of the most important things about cash flow is the liquidity to reinvest and compound the gain. I’m surely not saying that debt pay down isn’t valuable, as I’m a large proponent of that. I would much rather take negative early-year cash flow on a prime property with high debt pay down than cash flow on a lower quality asset.