Is positive cashflow possible on a new home? - Posted by Chip

Posted by Ronald * Starr(in No CA) on September 09, 2003 at 09:37:14:

Chip------------------

I have no way to know if your friend’s property is actually cashflowing, or if s/he is fooling himself or herself. Many people look at their monthly mortgage payment, with taxes and insurance–known as the PITI–and subtract that from the monthly rent and feel that a positive difference means that they have positive cash flow. This is a mistake and is common. Is your friend making that mistake? Maybe. Maybe not. I have no way of knowing, as I don’t know your friend and I don’t know what s/he is like. If s/he is an engineer, w/he probably has run some numbers and possibly the correct numbers. You know your friend better than I do. What do you think?

Have you talked with your friend about how s/he has done the cash flow calculation? Have you studied the numbers themselves and the assumptions underlieing the numbers? There are always assumptions. How realistic do they seem?

If you don’t know how to do a cash flow calculation, you are not ready to be buying rental properties, in my estimation. It is too easy to be sold a property which does not provide positive cash flow in reality when the numbers presented by others said it did.

If you don’t know how to “run the numbers,” I recommend that you study the topic. It is discussed in many real estate investing books, especially the better ones. There may be enough posts on the topic on this forum that you can do an archive search and study it here.

Good Investing********Ron Starr****************

Is positive cashflow possible on a new home? - Posted by Chip

Posted by Chip on September 06, 2003 at 20:30:14:

I’m in the process of buying my first investment property. It’s a new home in AZ, which I plan to use as a rental. It’s supposed to have positive cash flow. What makes me fairly confident is that a friend of mine recently did the exact same deal and his property is cash flowing, although barely.

But the reason I’m confused is that I just read on John T. Reed’s website that it’s almost impossible to cashflow a rental property. Is this true? How common (or uncommon) is positve cashflow on rental properties?

Depends… - Posted by randyOH

Posted by randyOH on September 06, 2003 at 21:37:36:

Chip,
You probably already know this, but it really depends on how much you put down. Any property will generate a positive cash flow if you put enough down.

If you are talking about no downpayment, then you will need a monthly rent of about 1% of the cost of the house to break even. And this assumes a low interest rate on your mortgage, say 6%. So if the house costs $150,000, you will probably need to rent it for $1,500 to break even.

Good luck,
Randy

Re: Is positive cashflow possible on a new home? - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on September 06, 2003 at 21:25:51:

Chip–(AZ)---------

He is generally right about that, at least related to single family properties. If you really put in all the expenses, you probably will find out that it is a negative cash flow, before taxes anyway.

In general for strong cash-flow it is best to buy in low-end areas, where the ratio of rents to property value are highest. Usually newer properties are not in the lower-end neighborhoods, which are typically older neighbor hoods.

But, you simply need to make some accurate estimates of costs and compare them to accurate estimates of rental income and vacancy rates.

Good InvestingRon Starr*****

Cost of funds - Posted by Wayne-NC

Posted by Wayne-NC on September 08, 2003 at 08:52:17:

Randy, I see this time and time again. Big Down Payment= cash flow. That is not the case. You have to factor the cost of the down payment before computing the cash flow. For exapmle, what if you have a 100% down payment? How would you compute the cash flow then? Money always has a cost no matter where it comes from. You could call it an opportunity cost of funds using economics terminology 101. The cost is the rate of interest charged if the money is borrowed or the investment income not earned if the funds are personal. This analysis has always paid off well for me. Could you tell me how you see it otherwise?

Re: Depends… - Posted by Chip JPN

Posted by Chip JPN on September 08, 2003 at 04:58:20:

Thanks, Randy,

I did know that in a vague way, but please don’t assume I know anything.

My downpayment is 5%. I was following the advice of Dolf de Roos to put down as little as possible (anyway that’s all I could afford because this is my first deal).

Next time I will try to buy smarter, but I wanted to do this deal for the experience. I didn’t have to do anything to find the property (a friend of mine did a similar deal), and I didn’t didn’t have to know anything about RE (although I am educating myself now).

Also, I live in Japan, so it’s difficult for me to choose properties.

If this property has neutral cashflow, I will be happy, because it should appreciate and I could eventually refinance and use the cash as a downpayment on another property. Does this sound like a reasonable plan?

Thanks in advance for any advice.

Chip JPN

Re: Is positive cashflow possible on a new home? - Posted by Chip JPN

Posted by Chip JPN on September 08, 2003 at 05:09:26:

Thanks Ron,

The estimates from the salesman show a positve cashflow, for whatever that’s worth. My friend’s property is cashflowing, but just barely, and of course he will take a loss for a while because of start-up costs, so I guess it’s more accurate to say his property should cashflow in the future.

My question is the same as I just posted above to Randy (forgive me but I don’t know the etiquette here):

Even if my property has neutral or slightly negative cashflow, it should appreciate and I could eventually refinance and use the cash as a downpayment on another property. Does this sound like a reasonable plan?

Thanks for your help.

Chip

I agree… - Posted by randyOH

Posted by randyOH on September 08, 2003 at 12:07:12:

Wayne,
I never thought of it that way, but I think you are absolutely right. Maybe that is what people mean when they talk about a property cash-flowing without mentioning the down payment. Makes sense.

Thanks for pointing that out.
Randy

Re: Is positive cashflow possible on a new home? - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on September 08, 2003 at 10:07:31:

Chip---------------

Please do not use real estate agents as advisers for real estate investing. Unless they are actively investing themselves and can prove it. Even then, I would put them lower as advisers than other local investors who are not real estate salespeople and the posters to this and similar forums.

You have to know yourself what you are doing. Would you recommend that a 15 year old start driving a stick-shift car without some instruction in how to stear and work the brakes and clutch? I feel that it is possible that you are in the position of being the 15-year-old driver here. It sounds to me as though you are just stumbling along at this time. Tnere is nothing wrong with being a beginners, none of us were born knowing how to be real estate investors, with the possible exception of Donald Trump.

However, my believe is that real estate investing is difficult enough that one has to study up on it for a few moneths before actually venturing out to spend money to buy properties. I suspect, from your questions and comments that you have not spent enough time studying. Have you read my post for beginning investors? Put “beginners success” into the archive search function of this main board forum of this CREONLINE.COM website.

DO you know what expenses to add up to get a projection of costs for the next year and beyond? If not, you are not, in my view, ready to start seriously spending money on investment properties. Have you read a book on property management yet? If not, I recommend doing that before buying or as you are buying. I recommend both Jack Reed’s managing book, found on his www.johntreed.com website, and Leigh Robinson’s “Landlording.”

I am not bery enthusiastic about buying brand new properties for rental investment. One usually pays a premium for new. It is probable that you will pay a far better price for a used property which will rent for the same amount. Have you studied the market prices for existing homes? If not, again I feel you are not ready to buy. Have you study the rental marketplace whre you propose to buy? Do you know the rents being charged by similar properties? Do you know how long it will take to get a property rented out?

If you have read my “beginners success” you know that there are three categories of income for rental properties. Appreciation is one of them. If there is appreciation, you will make money, even with a break even cash flow. If there is high appreication you CAN make money even with negative cash flow. Investors here in Coastal California have been doing that for decades. However, some investors in other parts of the country suggest that investors discount the effect of appreciation and just buy if properties provide an acceptable level of positive cash flow. I don’t know where you are and even if I did I probably couldn’t predict the appreciation you will experience.

If you re going to invest with appreciation as your dominant goal, over that of cash flow, I recommend that you buy in locations where you expect very high appreciation over the next few years. Also buy the types of properties that are likely to appreciate more than average. And invest with a strategy that assures higher returns if there is appreciation–such as with high leverage. You probably will have little cash flow, but then remember we are talking about investing to maximize appreciation profits, not tax flow profits.

I feel that NONCOASTAL California is a great place to invest for future appreciation. There may be other places that will be good also. For the past 5 years or so there has been great appreciation in NY, NJ, CO, MA and perhaps other parts of the NE USA> Whether that is likely to continue, I don’t know and don’t make any projections that it will.

If you believe in “regression toward the mean of appreciation,” you would invest in areas where prices have “lagged.” Where they have gone up LESS than that in surrouding or comparable areas. If you believe in that approach you might consider NM or TX along the Mexican border. There may be reasons for areas not to appreciate much and those reasons may continue and cause them to continue to lag. I don’t know why the low-appreciation areas as the way they are. It takes some studying to hope to at least partly understand what is going on. I’m not about to take the time to try to do that sort of analysis. There would be no need. I have already got my investment program and it does not involving looking for the “lagging” areas. Robert Campbell touts this approach. However I find his book “Timing the Real Estate Market” to be completely unconvincing in terms of using if for my own investing. Perhaps you will feel differently.

Now, I may be wrong about you. Perhaps you are ready to risk thousands of dollars on the salesperson’s recommendation. However, I worry that salespeople will say what they think you want to hear to convince you to buy. They don’t have to live with the long-term consequences of your making a poor purchase. You do. I feel it just does not sound like you are ready to drive an investment vehicle. Perhaps I am incorrect. I have no stake if you do or do not buy. I just hope you don’t run off the road and hurt yourself or wreck your investing program.

Good Investing*********Ron Starr************

Re: Is positive cashflow possible on a new home? - Posted by Chip JPN

Posted by Chip JPN on September 09, 2003 at 05:26:12:

Hi Ron,

Thanks for the advice. I meant to say that I didn’t automatically believe the RE agent. He gave me some spreadsheets with estimates; those are what I was referring to. And I agree with you that I didn’t do as much research as I should have.

But what about my friend who did a similar deal about six months ago? Isn’t the fact that his property is cashflowing a good sign?

Thanks,

Chip