Trouble Grasping This Concept:

[Chris Farinella]

“More valuable homes are likely to cash flow less, if at all, than lower value homes”

I hear this repeated a lot and haven’t yet heard or found the explanation. I assumed that more valuable homes would simply have much higher debt payments and taxes, but then I’ve seen the concept being talked about while referencing cash deals or various other methods of financing, so it seems the debt isn’t the main factor.

So why is it lower value homes generally cash flow greater than higher value homes?

[Drew C Grossman]

Quote from @Chris Farinella:

“More valuable homes are likely to cash flow less, if at all, than lower value homes”

I hear this repeated a lot and haven’t yet heard or found the explanation. I assumed that more valuable homes would simply have much higher debt payments and taxes, but then I’ve seen the concept being talked about while referencing cash deals or various other methods of financing, so it seems the debt isn’t the main factor.

So why is it lower value homes generally cash flow greater than higher value homes?

Hey @Chris Farinella this is a great question. 

Let’s start with a basic example …and assume we are paying cash. I’m going to use markets in Florida as an example.  

You have a $200,000 house in Central Florida that rents for $2,000 a month..2,000 / 200,000 = 1% a month in gross rents. 

You have a $400,000 house in Tampa that rents for $3,000 a month …3,000 / 400,000 = .75% a month in gross rents

You have a $900,000 in St John’s County, Jacksonville that rents for $5,500 a month …5,500 / 900,000 = .61% in gross rents.

Notice that the higher price point you get..the lower the rent / price ratio…making farther away from a 1%+ deal

Let’s assume that in this market taxes and insurance combined is 2% of purchase price per year. 

$200,000 x 2% = $4,000 
$24,000 yearly rent - $4,000 = $20,000 $20,000 NOI / $200,000 purchase price = 10% cash on cash return.

$400,000 x 2% = $8,000 
$36,000 yearly rent - $8,000 = $28,000 $28,000 NOI / $400,000 purchase price = 7% cash on cash return.

$900,000 x 2% = $18,000 
$66,000 yearly rent - $18,000 = $48,000 $48,000 NOI / $900,000 purchase price = 5.3% cash on cash return.

**not factoring in PM expense or reserves**

Adding leverage can also boost returns and this example above will hold true with financing when comparing apples to apples cost of capital. 

So why is the cash flow less in the higher side of the market? Simple ….for every $100,000 increase in price point the harder it gets to achieve that additional $1,000 in monthly rent. I am speaking very general with a long term rental approach as I know creative / short term rentals can fetch more rent. 

Also a majority of the demand for homes at higher price points are people who are owner occupants which buy homes not because it’s an investment but because they need a place to live. This can drive up price …

In most markets you have a balance of appreciation vs cash flow and you are usually sacrificing one for another…however not in all cases as the goal is to find markets with healthy amount of both!