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Cash flow. Or Lack of.

Everyone wants a property that they can put little or no money down (leverage), rent out for more than it costs (cash flow) and will be worth a ton more than they paid for it when it sells (appreciation).

Putting the three together determines if you have a good investment. Not all three have to be favorable to have a good investment.

Let’s say we buy a $200,000 house. We put $20,000 down (10%) and have a loan calculated over 30 years at 6%. That’s a monthly principle and interest payment of $1079. Add $221/ month for taxes and insurance (all these numbers are fictional). Our monthly payment is $1300.

The property closes and now we have two different rental scenarios. First, the renter moves in and happily pays $1500/mo. Gross cash flow, providing there were no other expenses is nearly $200 per month. The other is that it only rents for $1100. Now we’re writing a check for $200/mo. Not so fun!

If we had put more money down, say 30%, our payment drops by $240. Now we’re making money on a monthly basis. Sounds great but we have lost our leverage. Now were using our money instead of someone else’s.

After five years, we sell the property for $255,000. It has appreciated 5% per year. Let’s say the loan cost you $4,000 and it cost you another $13,000 to sell the property in commissions, escrow & title fees, and minor repairs the buyer asked for. You’ve made only a small dent in the principle so you pay off the $180,000 loan and are left with approximately $60,000 on your $20,000 investment. This assumes the whole time we were cash flow neutral. If we’ve made a payment for $200/mo for the last 60 months, we’re out $12,000. Now we’ve “only” got $48,000 on our $20,000 investment. If the same $20,000 had sat in the bank earning 5% interest, we’d be sitting on $25,525.

Again, all these numbers are fictional on one cup of coffee. There are so many other variables that need to be considered in the overall picture but this is a good primer on the basics. we don’t have to have positive cash flow to have a good investment (but it sure is nice). We’ve always got to consider what we could have done with the money for another use.

 

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