Investing for Cash Flow is a Bad Idea

It's obvious that the title of this post is the exact opposite of what 99% of investors seek. "Cash is King" right? Well, yeah...it sort of is and it sort-of isn't.

Here is where I would like to pause and say; start thinking on your own and stop regurgitating what everyone else is saying. Or, as my mom used to say "If everyone else jumped off a bridge, would you do it too?"..."uh...no, mom..."

"CASH FLOW"

If you ask any real estate investor what their most important investment metric is, 99% will say "cash flow." It makes perfect sense, I get it. If you have cash flow, everything else seems to fall into place. And if you are a full-time investor, you need cash to survive. Well, we all do technically....but what if you already have other sources of income?...the majority of investors work a W2 or 1099 J-O-B…so, why would you need cash flow?

LET'S TAKE A TURN AND THINK ABOUT THINGS ASIDE FROM CASH FLOW...HOW ABOUT OPPORTUNITY COST AND OTHER INTANGIBLES?

These concepts are abstract, but they are important. Let’s discuss.

OPPORTUNITY COST

We've all heard about opportunity cost, but it's hard to explain accurately. As an investor, we're naturally opportunistic...it's a survival instinct...it's hard to pass up a deal. When we see a wounded animal, we can't help but pounce on it. So, what is opportunity cost, anyway?

Here is a boring definition: the loss of potential gain from other alternatives when one alternative is chosen.

This definition assumes two things:

1. 1-That you have alternatives, and
2. 2-That the venture you choose will be successful

But what happens if you have a pile of cash, dump it into what appears to be a cash-flowing property, and your tenants all lose their jobs and refuse to leave? Shit, well you should have held onto your cash. And what if you have no alternatives?! We cannot change the past and we cannot predict the future…we can only define the here and now.

Here are a few questions for you to answer internally...or aloud, it doesn't matter. Preferably aloud if you're in a public place...answer loudly!

• Opportunity 1: If you had the opportunity to acquire a 4-unit, 100% occupied property worth $200,000 at a 20% discount from present value with 5% down, and rental income that placed you at <5% ROI would you do the deal?
• Opportunity 2: If you had the opportunity to acquire a $150,000 duplex at a 10% discount with a 75%LTV bank loan where the long-term tenants were paying 60% of market rent, leaving the property cash-flow negative by $50/mo. would you do the deal?
• Opportunity 3: If you had the opportunity to buy a $300,000 triplex with one vacancy at a 20% discount from list price that just covered your PITI payment and maintenance expenses, would you do the deal?

If you answered yes to any of these, you're on the right track.

Dissect the questions and the common theme is buying at discount….and what does buying at discount create?...equity! When you combine equity with appreciation and debt paydown, what do you get?? Wealth!

So here is what you are facing; an opportunity with zero cash flow (or perhaps even cash flow negative). According to 99% of investors, this is not a priority investment...it's simply not a deal worth doing and should not be considered. And here is why being in the 1% that believes cash flow is merely a by- product of opportunity is so important...let me tell you why this is a good deal:

1. You are in an instant equity position. Why is equity important? Because you can use it later. If you have a W2 job that pays your bills, the equity can sit in this property and build up as your tenants pay down the loan. Combine this with natural appreciation, and you've got gold in the property. Equity can be pulled and used to buy other properties, or you can save it all for a final sale and defer those gains by using a 1031 exchange. Free-and-clear is a beautiful thing….keep your day job now and take the cash flow from the property further down the road.
2. The note payment is covered by your tenants. Okay, so no cash flow, but the entirety of the note will be covered by your tenants. You just need to run the show and make sure you have good tenants that pay the rent. Piece of cake right. Just for shit's and giggles, I would go as far to say the examples above represent a good deal even if you have to pay out-of-pocket for routine maintenance or repairs...why?...because you'll get it back in the form of equity down the road...5 fold. And those expenses are tax deductible!

This is just the tip of the iceberg. Remember, if you were a "Cash-is-King" guy or gal, you would have passed on this deal for a cash flowing property.

LET'S TALK ABOUT INTANGIBLES!

Intangibles are the things associated with owning investment property that don't show up in the financial analysis. "Hassle Factor," for example...how much of a hassle is it to manage the property? This is the factor that drives a lot of rental property owners out of the business. And also what permits us as investors to acquire property from motivated sellers at discount.

Let's look at this deeper:

If you invest for cash flow, you are telling me that you would take a property with tenants that scrape by with two jobs as long as it has cash flows every month?...Over a stable break-even duplex with two older adults on fixed income that will die in their units.

Morbid, but it's reality...

Mr. Cash is King, do you think endless repairs, a tenant that complains every day, a property that has impending capital expenditures, abnormally high potential for turnover, possible future evictions, and slowly becomes home to everyone in your tenant’s family as they lose jobs and end relationships is worth the cash flow?

Now, I am Mr. Break Even with a hassle-free property and zero cash flow. My adorable elderly tenants keep a tidy house, plant gardens, participate in the neighborhood watch, and drink lemonade while sitting in their rocking chairs on the front porch...slight sarcasm, I know. But the truth is my zero cash flowing property will appreciate faster, have way less turnover, cause me less headaches, and get paid off by my tenants, creating a long- term equity position and cash-flow most investors would envy.

HERE IS MY CALL TO ACTION: STOP INVESTING FOR CASH FLOW AND INVEST TO OWN or CONTROL ASSETS... focus on the opportunity an investment presents, not whether or not it cash flows.

Back to the opportunity cost of investing. It is the duty of investors that have a w2 job to strategically acquire assets that can create enough cash to replace income acquired through a job. (all while dancing the delicate dance around the Debt-to-Income conundrum).

So, where is the balance?

Instead of focusing on immediate returns, look at other metrics better suited to predict future value. If you can own or control property that pays for itself now, do it. At the very least, you will have 5-10 years of debt pay-down and equity buildup, and offset W2 income through mortgage insurance and expense deductions related to the property maintenance and repairs.

Here is the point of this article....pay attention to your lifestyle, goals, preferences, dedication to your business, how much time you want to spend away from family, hassle factor, risk tolerance, motivation, and personal needs, rather than investing for a single metric like cash flow.

We’d love to hear your thoughts; drop us a line [email protected] or stop by the website for more information about investing in real estate https://investhypothetical.com/