General rule for cash flow vs total cash invested?

Question

Is there a general rule of how much total cash should be left in a deal, vs the monthly/annual cashflow?

For example, if I were to BRRRR a property and end up leaving a total of 24k cash in the deal, knowing that it should cashflow for 500-550 a month (conservatively $6k a year), that would be a 4 year break-even point, before factoring in asset appreciation. Would breaking even in 5 years be worth it? What about 10 years, etc?

Joe Villeneuve · Answer

DP = Down PaymentThe total cost to the REI is only the cash that comes out of their pocket. That should be only the Down Payment. The cash flow is what recovers that cost, so when the total accumulated cash flow, over the first few years, is equal to (or greater than) the total cost to the REI (cash paid), then the REI has recovered their cost, and they are making a profit from that point forward.If you have to pay added cost (cash) for any reason (i.e....negative cash flow, rehab, etc...) that adds to the cost and must be recovered before profit is made...kind of a step backwards, then once recovered, you're moving forward again.The reason for selling after your equity has doubled is you're losing money. I know it seems as though that added equity is gaining you money, but it really isn't. Here's why:1 - When you buy a property, you pay 20% DP, but that 20% buys you 5 times that cost in property value. In other words, you're buying a $100k property (for example) for only $20k. That $20k now represents $20k in equity.2 - When a property gains value (appreciates), the equity also appreciates at an equal rate, meaning for every dollar a property appreciates, your equity increases that same dollar. So if that same $100k property appreciated $20k (PV = $120k now), your equity would also increase that same $20k ($40k now). Sounds good, right? However...3 - When you buy the property, the original PV was worth 5 times the equity. Now, the PV is only worth 3 times the equity. That increase in equity has actually reduced the value of your equity.4 - When you sell the property, that $40k is now converted to cash, and moved forward into another property at, once again, worth 5 times the equity (Now $200k).5 - Also, if you were to buy 2 properties just like the first one, your Cash flow should also double.The value of real estate isn't in the cash flow and equity. The true value of RE is in what those two items represent in the form of future cash flow and property value. In other words, in the power of what it can buy.

Brian Silvia · Answer

Account Closed Agreed it does sound like a good deal. I’m guessing we’re going to run into a multi-offer bidding war so I’m trying to get a handle on how high my offer should be. Do you have a minimum CoC that you shoot for? The unit is already metered to support both possible doors. By 1031 I’m assuming you mean 1031 exchange? Still working on wrapping my head around all the lingo and options available, hah. @Joe Villeneuve thanks for your reply! I’ve read it a few times, and I’m struggling to follow what you’re suggesting. What is “DP”? Are you saying that you buy properties, rent then out until you get your money back, and once your initial equity is doubled, then you sell it and buy another property and do it again?

Account Closed · Answer

Joe raises a good point; consider a 1031 into a bigger/better property and repeat the process before the loan looses too much leverage.

Account Closed · Answer

@Brian Silvia Different folks have different criteria, but I think the numbers you provided make for an outstanding deal. With the numbers provided, the conservative CoC ROI is (500*12) / 24000 = 25%. Depending on the price of the property and your refi lender's ARV, you would likely be getting 25%-30% equity in the home for a steeply discounted price of 24k. For example, if the home's ARV was 100k and you just put a down payment of 25k on that property, you would have 25% equity, but in your example I'm guessing the home's ARV is much greater than 100k. Combine that immediate equity with loan amortization over time, and by year 4 you would not only be breaking even but would also have an even stronger equity position building your net worth. Another perspective to consider is the opportunity cost in your rent (step 3 in BRRRR), or in other words how else could you rent the property to increase the 25% CoC ROI to closer to maybe 30%? One example is could the cash flow be accelerated with strategies like renting by the room to potentially bring in more. You didn't give details on the rent strategy but rent by the room might make sense depending on the bed/bath.

Joe Villeneuve · Answer

There's more to it than that...at least the way I do it. I want to get all my cash back from the CF, wo the higher the CF, and lower the cash out (DP) means less to recover and a faster recovery. Then, once the equity doubles (pus closing costs) my DP, I sell, I move my equity forward before I lose too much money with the rising equity.