Cash Flow v. Appreciation

Posted by Monte Davis on Thursday, September 9th, 2010 at 11:30am

In the journey to discover where your money will work best for you, start with these questions:

 - What are my investment goals?

- Do I need "cash flow" or appreciation?

- How much cash do I have to invest?

- How much cash do I have in reserve?

- What's my experience / comfort level?

So, out of that, when the seminars are planned and the books are written, where does the emphasis fall? Cash flow. Nobody goes to a seminar to learn about negative cash flow and positive appreciation. They pay $99 to learn how to get "cash flow."

And yet, at the end of the day, those investors that buy in areas that have good appreciation do better than those who concentrate exclusively on cash flow. Let's explore that.

Can I get both, you ask -- cash flow and appreciation? Yes. It's actually pretty simple. Put more money into the purchase of the property.

However -- you can't have it all. Appreciation, cash flow, and leverage. They don't mix.

If you leverage, you're using someone else's money. You're giving your cash flow to that person. If you don't need leverage, then you're going to get all the cash.

These are the things you have to understand in crafting a purchase and you also need to understand all the things that can go wrong. Turn over, for instance, can really hurt you in the rental market.

- If you have cash flow of $100 per door,

- and your have turn over that will cost $1,200 to $2,000

....you've just eaten up your cash flow for the year.

Anyone can do a spreadsheet, run a cash flow analysis on a property, and come up with figures that make you say, "Wow!" However, if you really dig into the rental history, you're going to find that every 12 to 18 months or so, you have a turn over. Take that into account and divide it into the cost of the "make ready." Now take that away from your cash flow calculation.

- Projected cash flow: $2,000.

- Make ready cost: $1500

- Actual cash flow: $500

- Divide by 12-18 months: $30-$40

You've ended up with a break-even property.

Now, let's think in terms of appreciation. See that break-even property as a savings account or a college fund. Right now your kid is 2 or 3 years old. In 15 years, you're going to sell your property to pay for his tuition. Can you afford $100 a month for that investment?

Look at it like a savings, not an expense. Not only are you going to buy this investment, you're going to have tax benefits and get money back at the end of the year.

Yes, you may have some months with maintenance and vacancies. You may have to put extra money in, but -- bottom line? it is a break-even. If the tenants stay in place, they're paying the note and the expenses.

If the property has a track record of 5% appreciation -- and there are areas in Austin that double that -- and we compound that over the years you own the property, you're going to do very well with this investment. And, in 3 to 5 years, a period over which rents typically increase, you will start to have cash flow.

My best advice: Instead of buying two cash flow properties with no appreciation track record, buy one quality property. I'd rather help you buy that one good investment than sell you multiple mediocre properties.

The trick always lies in matching your investment goals with the amount of money you have to invest.

Next week, we'll look at the issue of cash, in particular, how you can use a self-directed IRA to better your cash position.

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