Don’t get me wrong. Cash flow is good (assuming it’s positive), but absolutely NO one has ever become rich from cash flow alone. Think about that for a minute.
Let’s look at a quick example. Let’s say you have a $100,000 property that generates $200 per month in positive cash flow. That’s $200 per month after all your expenses and debt service. That would give you $2,400 per year or $12,000 over five years in cash flow.
Assuming you follow our advice of maintaining a reserve account for each of your properties to cover future maintenance and repairs, you will have made $12,000 in net profit over those five years. This assumes that nothing unforeseen happens along the way such as a hot water tank or leaky roof requiring replacement, or a long-term vacancy.
If you’re going to put your investment capital, credit, and possibly your income at “risk” for $12,000, then you’ll need more than just cash flow to make it worthwhile. You need to be investing in markets that offer good appreciation potential. That is how you become rich!
Live where you want and invest only where the numbers make sense! This stresses the importance of investing in good markets and good neighborhoods.
Going back to our example above, what would happen if we averaged only 5% appreciation per year in addition to the $2,400 in cash flow? (Remember that the national average has been 6.2% going as far back as the 1940s.)
With only 5% appreciation per year you’d make over two (2) times more money in equity than cash flow alone. And with a 10% average rate of appreciation over five years you’d make over five (5) times more money in equity than cash flow alone.
Did you forget that appreciation in many markets used to be over 10% as recently as four years ago? Markets move in cycles and appreciation always happens as markets cycle off their bottoms. We are seeing it today in markets all around the country.
Of course, in addition to the positive cash flow and money made through appreciation, you also benefit from the amortization of the mortgage and the tax benefits through depreciation, tax deferred exchanges and lower capital gains when holding your property for more than a year and a day.
Now is the time to be investing with so many markets near their cyclical bottom or turning back up. Cash flow is great, and it’s the “glue” that keeps your investment together, but it’s the equity growth that will make you rich.
People should have active income, then passive income, THEN investment income. Ask anybody who bought a rental on HELOC money to verify this one…
Nice entry, Marco.
Good article. Of course, the fact that you can borrow money against your real estate, use that money to make more investments and not have to pay tax on the borrowed money… now THAT is a great reason to get into real estate.
I disagree with your article. It depends on your definition of “Rich”. For my definition of rich is how long you live at your current standard of living if you were not working. With positive cashflow I now make well over my expenses with reserve funds. As for me I will use the equity to then just leverage more cashflow. For to me cashflow has made me “Rich”
Borg: Only problem, not everyone will be able to pull more then 60-70 on a cash out refi; and add to the fact that MOST people are not able to find deals that good (we do, but we do it full time). Many investors (new and even seasoned) ask us how we find so many great deals and it because I have dedicated person looking all day, every day, for great deals not to mention having a system in place to track all those “not so good deals just yet, but might later” deals. So my question is: how many people have a pile of cash sitting around to buy/refi? Or how many people know how to raise private money to buy? I have piles of both and it’s still not that easy! However, I do agree that if you can leverage a little then it’s a great way to go. Over leverage will kill you.
Matthew: I think the main idea is that cashflow alone still has issues and just buying rentals for beginning investors will not make them rich. It requires a LOT of properties with cashflow (spread the risk accross multiple properties) and then you are rich. The wealth part comes many years later with mortgage paydown, appreciation, etc. Of course, I agree with you that if you can have enough passive income from NOT working then you are rich! I subscribe to the “NR” (New Rich) idea from Tim Ferris “4 hour work wee” that it isn’t how much cash you have in the bank but how much cash you have passively that fuels your passions and not working! You can live a millionaire lifestyle without being a millionaire.
Being rich is not just about the money. Although we were talking about cash flow where the money is involve the fact of doing this is a good experience how is your money used as a tool for having a business which sometimes makes you happy and that I would say being happy is more rich because it is hard to find but the money was just there.
Great write up Marco. You’ve been talking about housing market still has a ways to go. Does this apply to rental properties too? Would it be more prudent to wait out rental market property prices as well, to make sure there’s more appreciation when the cycle finally kicks up? With the big bust, it may take some time for real equity growth to happen.
It’s all good. Be patient, know what your trying to accomplish. Keep away from an abundance of things that take money out of your pocket. Keep looking for the ideal investments and as long as you keep looking and are realist with the time frames and the parameters of your investments, you should be fine. You can enjoy life while you are becomming wealthy and at the same time you set a good example for the ones watching you.
Appreciation in real estate is a myth! Home prices in general follow inflation rates. There are exceptions like flagstaff, AZ which limits the number of new builds… Portland and other cities do the same. This of course creates less supply so if demand remains constant prices rise.
Never confuse price with value… The value of a 2×4 is equal to a 2×4. And a set of 2×4’s in the shape of a home built 30 years ago is the same set of 2×4’s today. The difference is the price of the material and labor due to inflation or the perceived value of a location. As an example, it takes 20 dollars today to buy what 7 dollars would 30 years ago.
Always invest for cash flow first, then if you have an opportunity to realize a big gain due to some circumstance then you now have 2 ways to win. Speculate first and you can only with by finding a bigger fool to pay you more than you paid.
Do you typically advice investors to base their investment strategies on projected appreciation?
Never base your decision on “projected appreciation”. A market with sound economic fundamentals, a positive cash flow, and a good property on a good street in a good neighborhood will give you the appreciation you want over time.