Why Are You a Real Estate Investor?

About three years before “retiring” from a career in public school teaching, I started taking every seminar I could find on how to be a real estate investor. Yes, I had rehabbed a few houses, been a landlord many times before, bought distressed properties, and held onto real estate for appreciation, but I had never considered real estate as a career. In fact, I had never met a full time real estate investor outside my own family until I started going to seminars and got to know a few of the savvy, serious players.

In the last three years, I have exchanged business cards with many different types of real estate investors: passive income rental property investors, real estate entrepreneurs, realtors who also invest, private lenders, wholesalers, and rehabbers/flippers. 

When the real estate market turned downward in 2008, many real estate investors who were actually unwitting, overleveraged speculators found themselves with underwater properties they needed to feed by working longer hours at their day jobs. Many wholesalers closed up shop because their buyers, rehabbers,  could no longer obtain financing. Rental property investors became gun-shy because prices were going down. 

While so much carnage in the industry seemed a cautionary tale, it lacked a clear message to the one who could not see the big picture.

Why was it that just a few years before, real estate had been rocking and rolling and in 2008 it was at an almost complete standstill for many?

What separated those who would eventually reemerge and triumph in the evolving real estate market and those who would throw in the towel?

The answer, as I came to learn, was that to have endurance as a real estate investor--in fact, to have endurance as a small business person in general--one must know the difference between three types of money and that knowing how to use each one determines our survival and long term success as a real estate investor. 

CASH INFLUX
First, most people are familiar with Cash Influx. When you have a job that pays you a salary, hourly compensation, or even periodic bonuses, you are receiving Cash Influx. This is money that comes to you in chunks, regardless of size. Wise house flippers of short sales, rehabs, or wholesale flips have as their financial goal to use the money they get in chunks to fund property acquisitions that they can then hold for appreciation and/or regular cash flow. Anyone living off of Cash Influx dreams of one day living off of passive cash flow income that will set them free from the labor and time intensive task of operating the Cash Flow engine that some thought was going to set them free. They quickly learned that it feels more like  a JOB because you are always chasing after the next deal. When you start hearing wholesalers complain about the smaller margins they are getting for their assignments of contract, they are likely very dependent on Cash Influx events. Can you see how this is a prescription for trouble? It feels like a job to them because that is exactly what it is. When they stop marketing and hustling, their paychecks stop. 

CASH FLOW
Second, those who have purchased part or all of the income stream that comes from rental properties, notes, or businesses that produce regular passive income know that Cash Flow feels like a lot less work. Sure, there is the due diligence that goes into the purchase or financing of an income producing vehicle, but once it is theirs, it generates cash for them that finances part or all of their lifestyle. The financial goal of Cash Flow investments is that the passive income will eventually be greater than their lifestyle expenses. This is what many real estate investors really want when they say they want to be financially free. Although it takes time to accumulate enough passive income engines to fund one’s lifestyle, it is certainly worth the time. To know the need for regular Cash Flow is the beginning of a worthy pursuit. Orienting ourselves in the right direction is half the battle and better than finding ourselves years later enslaved to the constant need to create Cash Influx events that do not allow us to take a day off or go on vacation if we feel like it. 

APPRECIATION
Third, when real estate investors are able to time the market well enough to buy when prices are down, and then hold until their investment has gained in value so that when they sell they can realize a significant profit, they build equity that can be converted into cash flow. Until then, what one hopes will appreciate will more often be a cash flow negative investment that requires feeding unless one can use Cash Influx money to put enough money into the deal to bring down the monthly payments so that it cash flows. Many real estate investors mistakenly invest long term in cash flow negative properties with the hope that upon sale years from now, the Cash Influx will be worth all the negative Cash Flow in the intervening years and the risk of losing all their equity by not keeping up with the regular feedings the properties required. As an example, I have talked recently with realtors in my area who are pitching the relative low prices of homes to investors who “ …shouldn’t worry about the negative cash flow because you are buying at a tremendous discount.”   This sounds like the same speculation mind-set that caught many REI by surprise before the downturn in 2008. At that time it was thought that the market will keep going up. Now it is marketed that “you are buying at a discount” even though the property does not cash flow. Sounds like the same underlying message in different words. 

Wouldn’t it be wise to look at how the three kinds of money in real estate  interact to provide one with the needed guidance and balance in approach to provide for one’s lifestyle expenses now and build long term wealth for tomorrow? 

When one depends on only one kind of money, isn’t that a precarious position to be in? How can one safeguard oneself to be able to weather the vicissitudes of a changing market to build a balanced and fireproof foundation of wealth?

Here is what I suggest based on what we have learned about the three types of money:

1)    Those who depend on Cash Influx to fund their lifestyle would be wise to put money into more passive forms of investment so as to plan toward the future. Even if they like the excitement of finding, buying, and selling properties, they would be wise to start putting money into something that will provide income when they have either lost the motivation or the market to do their business. This can mean putting money beyond lifestyle needs into cash flowing rental properties as well as properties that will eventually appreciate to bring big pay days in the future. As well, it would be wise to have other business pursuits that will generate income. Many real estate gurus make as much money from marketing and teaching as they do in real estate. Some make more! They build up another income stream that supports their lifestyle as a source of cash flow. We can find ways to do the same. 

2)    Those who depend on future appreciation may become broke supporting cash flow negative properties while they wait for the market to turn upward so they can sell. Making sure one can put enough of a down payment into a property so it will cash flow is a big step in the right direction. Investing in single family homes is the way to benefit from appreciation if one can put enough of down payment into the property so the rent covers the mortgage payments. If one can solve the negative cash flow problem, then one can hold for the long term and cash out at the market peak—or at least once the property has risen in value a predetermined percentage, e.g. 50%. 

3)    Those who buy properties based exclusively on Cash Flow need a lot of properties to set them free financially. How many properties does one need in one’s portfolio to produce enough cash flow to be free financially? Answer: LOTS! And how many years does one have to work in the corporate world to accumulate that many properties? Answer: LOTS, probably. 

The lesson here is that it is important to balance ones effort and time into other types of money as well. Those who focus only on cash flowing properties would be wise to invest also in appreciating single family homes. Diversify into investments with quantum Cash Flow streams by investing in multi-family properties that provide larger scale. Consider becoming a private lender and joint venture with rehabbers who borrow your money to fix and flip, thereby leveraging someone’s effort and time for Cash Influx events that you can use to fund more appreciation-based investment opportunities.

In summary, when we have the big picture perspective that money has three different faces, we better control our long term survival and shorten our path to prosperity in real estate. Isn’t that why we originally got into real estate? We wanted to use real estate to build wealth. But in order to reach our goal, we need to balance money events  (Cash Influx),  money streams (Cash Flow), and the accumulation of long term equity (Appreciation). It is when we have these three strong strategies clearly in view with business models to match that we will consistently move toward true financial freedom--rather than wondering why we never seem to get closer to our goal and becoming road kill along the way.  
________________________________________________________________________
Brian Netzel has been a real estate and note investor since 1982 when he bought his first rental property on his public school teacher salary. He is now focusing on turn-around projects using distressed assets nationwide.
He is the acquisition manager for the private equity firm Inspired Capital Partners and the founder of SmartMoneyVision.com and RealEstateNoteInvestor.com which train investors to apply smart strategies that work in today’s real estate market.