General Real Estate Investing
Market News & Data
General Info
Real Estate Strategies
Landlording & Rental Properties
Real Estate Professionals
Financial, Tax, & Legal
Real Estate Classifieds
Reviews & Feedback
Updated over 8 years ago, 03/21/2016
How the deposit affects cash flow
I hear so much about how important it is to have positive cash flow when analyzing a property to buy and hold. What I don't hear is how the deposit you put down on a property affects the cash flow (by directly affecting the amount of money you need to borrow), and how that should affect your analysis.
For example, let's say I have $20,000 to buy a $100,000 property, but can qualify for a low interest FHA loan that only requires a 3.5% down payment ($3,500). Since my mortgage payment will be relatively high, let's say this causes my analysis to show a negative cash flow.
On the other hand, imagine if I had chosen to put the entire $20,000 as down payment. My mortgage payment would be lower, so let's say it's enough to provide me with positive cash flow.
So what's the difference? Should I turn down the deal just because I plan on only putting 3.5% down, just so I can keep extra cash on hand? Why does the deal suddenly get better when I tie that $20,000 as equity into the house? Whether my $20k is in cash, or is tied up in equity, why should that affect my decision based off of the cash flow rule?
What if I was paying 100% cash for the property? Of course the property is going to cash flow better than if it had a mortgage. But the deal may actually be terrible if you calculate it with a mortgage.
What am I missing here?
I know I can be guilty of being a bit loose with terms so to be clear: Yes, I was referring to using repairs as a way to negotiate the price down. There's no reason the amount the seller drops the price has to match the amount the repairs cost, for example. (Sure a more sophisticated seller may put the repair funds in escrow, and probably does in the markets you're working in)
I read the number working across all markets as 'I won't get into a market that has a 7.7 GRM' not '5.5 is the best GRM across all markets everywhere'. It's a quick way to figure out what markets you're priced out of / have no interest in.
I never said that @Account Closed, using my process you will never over pay for a single unit, and you don't have to run around and check markets to do your numbers. It's base is controlled by the rents, which is controlled the local market, and forced down by cost. Here is a deal from a few years back, ended up at 66k each, closing appraised them at 90k, CMA holds them at 95k last year, and we are seeing numbers at 100k-105k this year already.
Coming into a deal we run everything high for safety. Rehab came out of rents the first year, so that got removed from the cost after the fact. In all we are netting a little over $50k year and climbing with a $552,400 investment. We still have a few more years to go, and rents are climbing nicely each year, so it's turning into a really good deal. I think we will unload for a little over 1m when said and done; It will be 100% turnkey operation for investors looking for a solid operation to buy and enjoy for many years to come.
The only time I could see it not working out is when a massive rental bubble happens, then everything is inflating everywhere, and it really don't matter at that point as everyone is going to lose their shorts if they play and don't get out before the tide rolls as housing prices will follow rents.
Even at that point it would not matter as the property would profit as it stands. As the area was upgraded it's just going to go from a poorly managed property, to a nice property, and as rents bubble for the region you would just follow, and at some point fall back to your old earnings. So yeah...
The "cash flow rule" (and I'm not sure how you define this "rule") is only one piece of the pie.
More downpaymentreduces loan interest paid and reduces the minimum hazard insurance requirements but It reduces liquidity which is so important in life.
Also, placing a rule of assuming 100% financing is not something to do every time unless you intend to do 100% financing which I don't recommend. Do the calculation based on the loan options you have.
No one house and tenant are alike and despite what it seems, it's a grind to make money on both the front and back end so start small so you can learn all the **** a blog can't teach you.
Keep in mind, the longer you "buy and hold", the more money you will fork out in repairs and upgrades. A brand new Home Depot kitchen today is dated in 10 years. So you may as well add
new kitchens,
baths,
maybe a roof,
probably a hot water heater, maybe an HVAC,
maybe siding and Windows, definitely floors unless you go tile...
to the "cash flow" model if your looking long term or expect to lose in appreciation rates relative to the guy up the street that just sold brand new trendy stuff.
"Less is better than more, sooner is better than later"
Originally posted by @Andrey Y.:
Originally posted by @Levi T.:
I always run it as 100% financed, easy numbers to work with, and safer. Things I look at when doing deals:
1. At a glance; I want to figure out the gross cap. This at least lets me know if the income to property cost is right. If this don't work out, it's not worth learn more and I turn down the deal.
2. If gross cap is good. I dive into the net cap to insure it is cash flowing. Lots of times this is where bad management has run the rental into the ground. Don't expect to unload utilities or basic operations cost, however late pays, evictions, and run down units are easy to fix.
3. Finally LTV/Market value at closing without improvements. Leave plenty on the plate to insure you can get out if something goes sideways, plus that's your bonus profit after cash flow.
Buy and hold is like a slow flip, you want to earn at a higher rate than you can get on the stock market, then kick it the bonus earnings on exit.
*via my iPhone
You mentioned gross cap. Is a higher or lower gross cap better?
Higher is always better. Treat it like the first hat being tossed into the ring. Yesterday I looked at a deal for a residential/commercial deal with some other SFH combo. They said the property had a gross income of $362,000, with a net of $268,000. Long before I got the net I already know it was a bad deal as they wanted 4.3 million for the deal... that GCR is coming back at 8.4%. That's run as fast as you can asking price. They would have to come down to at least 2.5 million to even start to talk, but it's turn key so that's where it would sell at with a GCR 14.5. That's basically my line 15%, I know deals just are nowhere close to happening at that point, you got my attention at 20%+. I've come to these numbers by going back and looked at my old deals over and over, see what won, what loss, what did better, then just mechanized the process. If you want to make a lot of money, you can't get stuck in the work, it's mechanizing everything so you can move more quickly and get more deals at higher volume. You also need to do the same with the property management. What works for managing 10 units wont work for 50, and what works for 200 units hardly will work for 2,000 units.
Originally posted by @Matt Donley:
I hear so much about how important it is to have positive cash flow when analyzing a property to buy and hold. What I don't hear is how the deposit you put down on a property affects the cash flow (by directly affecting the amount of money you need to borrow), and how that should affect your analysis.
For example, let's say I have $20,000 to buy a $100,000 property, but can qualify for a low interest FHA loan that only requires a 3.5% down payment ($3,500). Since my mortgage payment will be relatively high, let's say this causes my analysis to show a negative cash flow.
On the other hand, imagine if I had chosen to put the entire $20,000 as down payment. My mortgage payment would be lower, so let's say it's enough to provide me with positive cash flow.
So what's the difference? Should I turn down the deal just because I plan on only putting 3.5% down, just so I can keep extra cash on hand? Why does the deal suddenly get better when I tie that $20,000 as equity into the house? Whether my $20k is in cash, or is tied up in equity, why should that affect my decision based off of the cash flow rule?
What if I was paying 100% cash for the property? Of course the property is going to cash flow better than if it had a mortgage. But the deal may actually be terrible if you calculate it with a mortgage.
What am I missing here?
I feel like the entire thread somehow got derailed off topic. I personally think if you have to put in real cash, it's just not a good deal. Your deals need to cashflow in the bad times to be worth it. There's only two times in landlording; Normal and Bad. The upside to the business is capped by having a normal operations with no repairs and no loss in rents. It's not like you can keep selling the same unit over and over to make more money like you do in other businesses.
The lending curve comes in as you start off having to put in cash for the deals, then over time as you build relationships with banks, and show that you are making not just good deals but amazing deals, they will start to lend you capital more freely. When they look at your deal with a 40-60LTV and the next guy is coming in and paying full price or higher for a deal, they will give you very decent offers on loans. As your deals sit they gain equity, lots of it hopefully, and at some point commercial loans will let you lean on a old property that has plenty of equity. I recommend trying to pay down one of your properties quickly so you get a base to work with.
Hint: if your LTV is under 60, your always gaining equity with each deal, so they don't really lean on the fist property, tho it's attached. So over time your portfolio has a continues LTV that is below 60.
Levi Thorton this does not address any of my questions and I'm even doing the math for you based on your parameters.
Can you just answer the questions without going into some anecdotal folk story that has nothing to do with what we are discussing?
Start with how over stating operating expenses by over 18% is useful.
Your phrase "its base is controlled by the rents" Sounds like meaningless guru speak. Can you explain what that means or are you just parroting a seminar?
Now I agree with putting more cash down than the min, but my thought is that if all you have is 20k I wouldn't put it all down. How much are you setting aside for repairs and vacancy? I'm just not a fan of having all my money tied up. How about you keep the 20k and use creative financing like the brrr method.
you are exactly correct. Cash flow is directly effected my the down payment. But I have always seen this as, the less money you put down the better the deal needs to be. Because one of my main criteria for purchasing is amount of cash due to my goal of early retirement. Almost all of my local banks require either 20-30% down. Or you can do hard money and get closer to 100% financing.
@Matt Donley The reason we don't consider adding more money to the deal to get a better cash flow is because A) the deal should CF at 20% down no matter what and B) If that extra money is tied up in equity then you cant use it to put a down payment on another house to keep expanding your portfolio
@Account Closed I have seen where you have posted this somewhere before and yes I understand what you are doing and that it works for you. You seem to fail to realize that you are very well informed and familiar with a niche market like Hawaii. This does not apply to 90% of the country and especially not to most beginners.
On top of that they way you go about voicing it is rude and intended to stir the proverbial **** pot. If all you want to do is troll people then please do it somewhere else. If you are truly a believer in what you say then write a blog post or at least start your own thread to discuss it on and quit trying to hijack other peoples threads.
Originally posted by @Kevin Harrison:
@Account Closed I have seen where you have posted this somewhere before and yes I understand what you are doing and that it works for you. You seem to fail to realize that you are very well informed and familiar with a niche market like Hawaii. This does not apply to 90% of the country and especially not to most beginners.
On top of that they way you go about voicing it is rude and intended to stir the proverbial **** pot. If all you want to do is troll people then please do it somewhere else. If you are truly a believer in what you say then write a blog post or at least start your own thread to discuss it on and quit trying to hijack other peoples threads.
Kevin you are uninformed. There is no business parameter that requires a property to cash flow, how ever the hell that is defined, at 0%, 10%, or even 20% down. Cash flow is not a guarantee and as I stated before if the need for cash flow is absolute it is because you are poor or a poor investor and will have to pass on very profitable investments.
I am tired of The uninformed throwing out FAKE analysis and bumpkin definitions of words that are incorrect. This forum is littered with them. I challenge you and Levi to follow through and explain his/your position.
I do invest in three states and what I am stating is viable in all 50.
So please step up and prove Levi right or me wrong. Please take that as a personal challenge.
I am not smart enough to argue with @Account Closed on this even though he is wrong about 95% of the market in Wyoming. His method may work in Jackson Hole or possible some places around Sheridan. The problem with arguing with Bob is he is abrasive and irritating, but make no mistake he knows his stuff. Most of us invest for cash flow, he invests for maximum return. True appreciation in my market rarely happens and it is highly likely our local values will start dropping not rising. You cannot take a state with less than a million people and have layoffs of hundreds at a time across the state without fall out to real estate prices. Ten years ago Bob's method of investing would have made me rich in many of my markets, 20 years ago it would have made me wealthy. Unfortunately 20 years ago I was both a poor investor and poor. Timing is everything. If I understand part of Bob's method it involves having some serious cash reserves or income streams for at least a part of the time. We can learn a lot even from those who are irritating. I wish I knew all that Bob knows.
There are a lot of good nuggets in this post. Setting up a spreadsheet that analyzes all of the different aspects talked about in this thread can really be effective in comparing apples to apples. The Excel spreadsheet that I have has ROI (cash on cash) with and without appreciation based on different loan products, ARMs 3/1 & 7/1; 15 year fixed and 30 year fixed. This helps me decide how long to hold the property. I figure appreciation based on the average or median (we are in a non-disclosure state so average sometimes gets skewed with many solds being reported as $0.00) price increase based on the micro-segment (condo, townhouse, single family, multifamily, neighborhood...etc) of the market that I am investing in (Idaho Falls or Victor, Idaho or Jackson, Wyoming), where we are at in the cycle, and how long I plan on holding the property. This is one bottom line on the sheet.
The second bottom line on the sheet is the cap rates net and gross.
As @Account Closed pointed out, cash flow is not as important to cash heavy investors playing the low maintenance appreciation game. But it is important if you are trying to look ahead to finance your next deal and don't have a lot of cash or income to float the next deal. You do need to ask your CPA about the depreciation factor as well. From the way that I understand it to depreciate a residential property it needs to be "available for rent".
There are lots of ways to skin a cat but I personally think it is helpful to set up your own spreadsheet with everything that makes sense to you and then over time pay attention to which segments of the sheet make the most sense to you.
@Account Closed @Jerry W. I never said that Bob was dumb or anything of the sort. I have a problem with him hijacking other people threads to tell them they are dumb and poor for not doing it his way. I would love to see Bob write a blog post or start his own thread giving us examples and explaining his method and why its superior. The question asked on this thread and many others bob has done this too is unrelated, what does the "deposit VS. CF" have to do with calling people poor because they are not doing it his way and he does not value CF. Not every one has huge cash reserves and im sure there was a time when he was starting out that he couldn't do what hes doing now. but he seems to have forgotten that people have to start somewhere and were not all making 6 figures at our W2's and we don't already have a portfolio to support us while we wait out the market.
Bob, please start your own thread so we can discuss this like adults and maybe we can all learn something from you.