The Cash Flow Fiction

Cash flow fiction: The story told to most novice investors either by Real Estate professionals such as Brokers, property managers or gurus who write books on how to retire rich making money while you sleep.

Although cash flow is one of, if not the most important part of any investment property the truth is that small properties with four units or less will not provide the income these novice investors think it will unless they have less than 50 LTV (Loan to Value) meaning then have 50% or more in equity in the property or they manage the property themselves.

The problem is that small properties have many expenses that are overlooked and not advertised to be part of the equation to determine cash flow. A lot of self-proclaimed experts do a cash flow equation as flows:

Gross income (rent/laundry/parking) – Total expenses (Mortgage/maintenance/utilities/taxes)= Cash Flow

The problem is there definition of "total expenses".  Many expenses are overlooked by novice investors who do not have the experience to plan for the worst-case scenario. If you get some sort of financials on a property you will most likely receive the following

Expenses provided by most brokers:

• · The mortgage (not given but implied) 
• · Taxes
• · Maintenance
• · Utilities
• · Vacancy 5-8% ( not realistic)
• · Management 10%

When people are doing the numbers on their cash flowing properties, especially the small properties they forget the following:

Realistic Vacancy (12%) Most novice investors will calculate vacancy at 5-8% this is not even one month rent (8.33%) so if your property is vacant for one month you are already off to a bad start.

Realistic Maintenance – You must confirm the cost of maintenance on a property or do your own numbers. You can not rely on the numbers given to you by the seller or his/her broker. Maybe they did not take care of the property or did the maintenance themselves, a realistic maintenance budget is 10% per month and that is only for ongoing repairs. Most investors don’t realize that if your tenant moves out the cost to have the unit prepared for a new tenant can eat up all your cash flow of the last year.

Depreciation of the building – this is calculated at 4% per year and most people say it is a paper loss but in reality some day you will need a new roof or other major expense and if you don’t add it to you budget you can eliminate all your cash flow of over 10 – 25 years with a single expense. And don’t forget today a roof may cost you $10,000 dollars but with the rising cost of living in 20 years it will cost a lot more!

Expenses to consider

• The Mortgage
• Mortgage insurance (PMI or MIP)
• Property Taxes
• Property Hazard Insurance
• Flood Insurance
• Earthquake Insurance
• Water
• Sewer
• Garbage
• Electricity
• Natural Gas
• Propane
• Turn over cost (Cleaning/painting/possibly a lot more!)
  
• General Maintenance Upkeep
• Landscaping
• Repairs
• New Appliances
• Capital Expenditures (roof, furnace, hot water heater etc..)
• Office Supplies (stamps, envelopes)
• Accounting
• Legal
• Software
• Gas/Mileage
• City Taxes
• Advertising
• Payroll
• Property Management
• Vacancy Rate
• And the one thing almost everyone forgets about YOUR TIME!! Because if you think your going to be sitting on a beach in the sun while your bank account fills with money, you need to wake up investing in real estate takes work! It worth it to do the work but you must work to make it in this game.

I’m not saying that you can’t be successful investing in small rental properties or that you won't make any money doing so. If you plan for the worst and a property still maintains a positive cash flow chances are it is a good investment 

"Assets put money in your pocket, whether you work or not, and liabilities take money from your pocket."

                         Robert Kiyosaki

All I am saying is cash flow is not going to make you rich and create this passive income for you to spend your life on vacation sipping mojitos on a beach with nothing to worry about.

By:  John Lameck