Positive Cash Flow is The Elusive Beast in Real Estate
Through every cycle, many real estate investors forget why they invested in real estate in the first place. When the market appreciates, we all come to expect that real estate prices will rise forever. Why not pay full asking price for a property when it will appreciate 20% in one year?
If you put 10% down on a $200,000 house, for example, you could earn 200% return on your money. Never mind that the house could only rent for $900 a month. Assuming a 7% interest rate, the interest only payment is $1050 per month. Add taxes and insurance into the mix, and you’re looking at a negative cash flow of $250 a month. Ouch!
The logic of the last few years was that the appreciation would wipe out all negative cash flow sins. The reality of today is very different as many wannabe real estate investors are experiencing.
Ask any grizzled real estate investor and he would tell you that positive cash flow from a single family rental house is an elusive beast.
But what about all those other investors who live off their income properties? First of all, notice how it’s always “other investors” who are finding success? Those “other investors” paid down their mortgage to the point where their payments are less than their rental income. So if they own a house that is worth $200,000 but they only owe $50,000 to the bank, their payment would be $333 a month, fully amortized. Since we assumed that the rental rate is $900 per month, their net income is $900 - $333 = $567.
That’s positive cash flow, is it not?
The answer is yes, but at what price? If they only owe $50,000 to the bank, they have $150,000 of their money in the property. What is their return on investment?
Let’s work it out. $567 per month in net profit equals $6,804 per year. Divide $6,804 by $150,000 and you’ll get 4.54%. That’s right folks. The “other investor” is getting a whopping 4.54% return on their investment. Can you think of another investment vehicle that can beat 4.54% returns? Stop when you get to 100.
Did I mention that being a landlord is hard work, yet? You’ve heard of collecting rents and clogged toilets, haven’t you? Nuff said.
So why the heck would anyone want to invest in real estate?
That’s a really good question. In fact, it should be the first question that any wannabe real estate investor should ask. The second question should also be the same as the first question. Wannabes should ask themselves this question at least three times.
If they pass this preliminary screening process, they will see that the true answer to why they or anyone else would invest in anything is…cash flow.
What?!?
We all invest for cash flow. I don’t care if it’s a stream of cash flows or one big cash flow (cash chunk?) in the end when we sell; we all invest for the cash flow. And this cash flow has a price. Find the right price and the cash flow becomes that much sweeter.
For example, let’s say that we bought the rental house mentioned above for $110,000 instead of $200,000. Our interest payment would be $578 per month based on 10% down. Add taxes, insurance and property management fees, and we’ll be looking at $853 per month. All of a sudden, we’d be looking at $900 - $853 = $47 per month. Yippee!!
Not only that, but our return on investment is ($47 x 12) / $11,000 = 5.13%. The number is not stellar but it took a lot less money to earn that return. By the way, $97 a month in positive cash flow on a single family house based on 10% down is nirvana in real estate investing land. Don’t believe me? Go ask your local grizzled investor.
All right, so how do you find the $110,000 house? That is a question for another article.
Like I said, “Positive cash flow in real estate is an elusive beast.”
Alex Tran is the publisher of http://www.ezsuggestions.com/blog
For many years, Alex worked very hard so that he could become a lazy bum some day. Then he realized — why wait until he turns 65 to become a lazy bum? Why not find ways to invest for time today? That question was the genesis for http://www.EZSuggestions.com, where Alex shares ways to invest and not have to work so hard. Go read his often irreverent, but insightful, writing on how to invest for time instead of money. After all, what good is money if you haven’t got the time to spend it?
Article Source: http://EzineArticles.com/?expert=Alexander_Tran http://EzineArticles.com/?Positive-Cash-Flow-is-The-Elusive-Beast-in-Real-Estate&id=618190
