Cash-Flow or Equity Upside - What is Better ?

[Thomas Beyer]

We all want cash-flow AND equity upside. This used to work quite well in W-Canada, specifically in Alberta. This is now much more difficult as prices have risen substantially in AB, SK and BC, and cash-flow is low.

What is better: a house or building with ongoing cash-flow but little or low equity upside, but lower risk due to cash-flow .. or: a low or no cash-flow property (i.e. low CAP rate) with rent growth and more equity upside ?

I.e. what is better: a building in Ontario or Texas or Oklahoma or BC with 3-5%/year rent growth but substantial cash-flow with a 70-80% LTV mortgage (i.e. betetr cash-on-cash ROI), or a highly priced building in Alberta with significant rental and equity upside, but almost no or negative cash-flow even with a 65% to 70% mortgage ?

We argue for the former .. more sustainable cash-on-cash ROI upside with less risk .. more sustainable .. and we have commented extensively on our website on what other markets beside Alberta make sense today ... but I`d like to hear your view !

 

[joeiannuzzi]

Excellent question Thomas and one which certainly deserves attention. Ideally, every investor would like both but if I had to pick one side over another, it would be cash flow and here are my reasons:

Capital Gains investing is a form of gambling based on future expectation of market activity. It may be based on very strong economic fundamentals as is the case for Alberta, but it is still based on something which has not yet happened.

The present value equation which is taught in mathematics/finance classes [FV=PV(1+r)^n] states that a dollar in the present time (cash flow) is worth more than a dollar in the future (capital gains).

One cannot pay today`s expenses such as insurance and maintenance costs with equity appreciation, but must use cash flow. Or stated differently "You cannot eat equity"

In REIN we are always told to run our real estate like a business and in businesses, they always talk about earnings (i.e. cash flow) and leave the equity appreciation discussion in the background.

For a more detailed discussion of the cash flow versus equity investing question, I would encourage readers to pick up a copy of the book "Who Took My Money" by Rich Dad author Robert Kiyosaki

 

[DonCampbell]

Hi Thomas,

I guess it all depends on the goals of the respective investor. There is no black and white answer tothis, however any veteran investor, such as yourself knows that it is very difficult to carry very many negative cash flow properties. In fact, it is financial suicide to carry lots of these.

Obviously a combination of the two is the ultimate world (something you can achieve in the Technology Triangle in Ontario) The good news is, due to the predicted plateau in Alberta, many Members are able to start achieving cahs flow once again. Some with substantial postive cash flow. This plateau, according to the economics, will not last forever and then we will see the market cleaning itself up again, tighter supply leading to higher prices. So it is within these plateaus that opportunity awaits.

Cash flow is showing up in areas across the country again (in no particular order):

1. Abbotsford
2. Calgary
3. Red Deer
4. Grande Prairie
5. Kitchener-Waterloo-Cambridge
6. Hamilton
7. Halifax
8. Barrie
9. Chilliwack

And many other regions.

To answer your question directly, cash is always king and sometimes you have to work your property analyzer form backwards to see what it would take to make the property work. And thanks to increased rents (which we will once again see a large jump in rents come the one-year anniversary of the `1 year rental increase law in Alberta`, we will continue to see markets ebb and flow (prices increase faster than rents, then rent increase to catch-up then the cycle repeats itself.)

Many put there money outside of Canada (US, Central America) over the last year, only to see their investment returns weaken substantially as our dollar skyrocketed (the returns look good until the exchange rate shift is factored in). There is another over $700B of sub-prime mortgage to be reset between now and December 2008 in the US (to date only about $280B has occured) so in 2009 we should see some strong buying opportunities for that vacation property down south. Our predicted collapse of the markets in Las Vegas, Phoenix, key parts of Florida and other overhyped destinations is occuring and will continue to be a mess until then.

A GREAT time to be a Canadian for sure! Thanks for the post!

 

[gpdu]

There is no way for positive cash flow in Chilliwack, let alone Abbotsford.

 

[Nika]

Hello Don,
I have noticed that you left out Edmonton from the list below. Is the return of cash-flow bypassing Edmonton, or was it just on oversight (I’m betting on the latter, but just wanted to make sure ;-)

Many thanks,
Nika

QUOTE (DonCampbell @ Oct 29 2007, 11:01 AM) Hi Thomas,

I guess it all depends on the goals of the respective investor. There is no black and white answer tothis, however any veteran investor, such as yourself knows that it is very difficult to carry very many negative cash flow properties. In fact, it is financial suicide to carry lots of these.

Obviously a combination of the two is the ultimate world (something you can achieve in the Technology Triangle in Ontario) The good news is, due to the predicted plateau in Alberta, many Members are able to start achieving cahs flow once again. Some with substantial postive cash flow. This plateau, according to the economics, will not last forever and then we will see the market cleaning itself up again, tighter supply leading to higher prices. So it is within these plateaus that opportunity awaits.

Cash flow is showing up in areas across the country again (in no particular order):

1. Abbotsford
2. Calgary
3. Red Deer
4. Grande Prairie
5. Kitchener-Waterloo-Cambridge
6. Hamilton
7. Halifax
8. Barrie
9. Chilliwack

And many other regions.

To answer your question directly, cash is always king and sometimes you have to work your property analyzer form backwards to see what it would take to make the property work. And thanks to increased rents (which we will once again see a large jump in rents come the one-year anniversary of the `1 year rental increase law in Alberta`, we will continue to see markets ebb and flow (prices increase faster than rents, then rent increase to catch-up then the cycle repeats itself.)

Many put there money outside of Canada (US, Central America) over the last year, only to see their investment returns weaken substantially as our dollar skyrocketed (the returns look good until the exchange rate shift is factored in). There is another over $700B of sub-prime mortgage to be reset between now and December 2008 in the US (to date only about $280B has occured) so in 2009 we should see some strong buying opportunities for that vacation property down south. Our predicted collapse of the markets in Las Vegas, Phoenix, key parts of Florida and other overhyped destinations is occuring and will continue to be a mess until then.

A GREAT time to be a Canadian for sure! Thanks for the post!

 

[DonCampbell]

QUOTE (gpdu @ Nov 1 2007, 02:48 AM) There is no way for positive cash flow in Chilliwack, let alone Abbotsford.

There sure is. As a matter of fact, a number of Members have been doing very well in the area. They are using the filter system and focusing on `relationships` and are uncovering some VERY good deals. You may want to ignore the MLS and start looking at alternative sources. Once it has hit the MLS, others have already picked it over.

Duplexes and fourplexes are doing very well in both cities.

 

[gpdu]

QUOTE (DonCampbell @ Nov 1 2007, 09:13 AM) There sure is. As a matter of fact, a number of Members have been doing very well in the area. They are using the filter system and focusing on `relationships` and are uncovering some VERY good deals. You may want to ignore the MLS and start looking at alternative sources. Once it has hit the MLS, others have already picked it over.

Duplexes and fourplexes are doing very well in both cities.


How much down payment they put down? When saying positive cash flow, I would tend to think 20% down using LOC at prime rate, and 80% mortgage, and the rent covers both mortgage and the interest on the down payment, plus all other expenses. It is hard to do that in Chilliwack.

For example, any 1/2 duplex is selling in excell of $250,000. Assume you can put a suite downstairs to make it two units. Assume rent $900 up and $650 down. The rent/price ratio would be 7.44%. To cover everything like I said, you need the ratio to be 9%.

Maybe you can get a deal to make it 9% using `relationships`, I do not know.

 

[Peter]

QUOTE (gpdu @ Nov 1 2007, 11:53 AM) How much down payment they put down? When saying positive cash flow, I would tend to think 20% down using LOC at prime rate, and 80% mortgage, and the rent covers both mortgage and the interest on the down payment, plus all other expenses. It is hard to do that in Chilliwack.

For example, any 1/2 duplex is selling in excell of $250,000. Assume you can put a suite downstairs to make it two units. Assume rent $900 up and $650 down. The rent/price ratio would be 7.44%. To cover everything like I said, you need the ratio to be 9%.

Maybe you can get a deal to make it 9% using `relationships`, I do not know.

The cashflow that you will be able to get from a property really will depend not only on the property itself (ie type of dwelling) but also on the financing structure that you choose. For example, the interest cost on most LOCs` is prime, so assuming you borrow the 20% downpayment from there, your monthly cost would be about $260. If you finance the remaining 80% with an extended amoritization or even an interest only payment, you would be looking at payments around $1050/month. Combined, your financing costs are just under your total rents which is where you need to really evaluate your actual costs to maintaining/owning the property.

Hope that helps,

Thanks, Rebecca (for Peter Kinch)

 

[Thomas Beyer]

WOW .. so many replies .. seems to have hit a "nerve" in that I love to buy more at home but find the prices somewhat in the nosebleed category @ sub 5% CAP rates ....

We also like, as Don Campbell mentioned, cash-flow AND equity growth .. with a decent leverage .. as then of course cash-on-cash ROI over a say a 5 year period is very high !! We have put a comparson of high leverage with cash-flow comparison of Dallas vs. Alberta on our website in the strategy paper .. and it shows that even with modest rent/equity growth of perhaps 4-5% higher cash-on-cash ROIs can be achived in lower priced markets than in high prices Alberta with low leverage .. henec, at least the moment, we are holders in Alberta but not buyers ...

We have started buying in the US (Dallas, a 300 suiter @ 42/door) in September 2007 .. plus a 200 suiter under contract @ 35/door .. but of course the question is: how low will the US $ fall .. $1.10 ? $1.25 ? In a recent presentation at the Calgary Real Estate Forum (late Oct.) by TD Bank`s chief economist Jeff Rubin he stated "a nickelback" .. i.e. $1.05 is his expectation for 2008 .. and boom, only 6 days later we are there already .. so what is better: a Dallas based building @ 42,000/door with cash-flow and equity growth or a property in Edmonton @ 110,000/door with a 50% leverage (then it cash flows) .. and equity growth ?

One factor to look at is also price of an old buidling vs. replaceemnt cost .. and we are at best 50% of new construction prices right now .. so substanially more upside even in Edmonton .. but we`re also hitting a "rent ceiling" in that many tenants cannot afford a $850 for a 1BR or $1100 for a 2BR anymore ... so how much rental upside do we still have in Alberta ? 10% 20% ?

We are still owners in Alberta as we also think rents will rise as will values/equity .. but the cash-to-close is now quite high in Alberta .. most deals I see I can get a 50% LTV at best going in .. unless I use an expensive boutique lender at much much higher interest rates ...

so yes, we`re starting to also look in smaller but promising towns in Ontario and BC .. although I don`t like the rent control side there .. less upside than in SK or AB or TX with landlord friendly jurisdictions ...

 

[gwasser]

I think way back I already gave an opinion on this issue. So now, what about an example about what I currently love in Calgary regarding positive cashflow. http://www.mls.ca/PropertyResults.aspx?Mod...p;ps=10&o=A

This is a link to the MLS pages for a senior assisted living complex in N.E. Calgary. I just bought my 4th unit in this complex and I sit on both the Condo Board and Rental Pool Board, which are basically one and the same. I am not sure what will come through on this forum, so I copied and pasted the same stuff here below.

The complex is approx. 5 years old, and in the first few years there was lots of oversupply from the competition and it was plain tough to fill a 147 suite complex which can accommodate up to 190 senior citizen tenants - typically in the 75 to 85 year range. These are very respectable and stable renters, except in one morbid aspect. Yes, I am sure you can guess what that is. Every month, approximately 5 to 7 tenants move on; either to higher care or they litterally `pass on`. Usually not an unpleasant way to go. Enough said.

Overall the tenants love the place where they get limited medical help, there are emergency alarm monitors everywhere, there is a common dining hall where 3 meals per day are served (which is included in the `rent`) and there are social activities and facilities: including a movie room, Bistro and bingo evenings. The place is managed by an excellent staff with lots of experience in senior assisted living.

cashflow is great, depending on the unit type, right now, after costs (including condo fees but excluding property taxes) between 900 and 1300 per month. I am sure this meets all your REIN requirements. Appreciation has been modest for Calgary standards, partially because investors are not familiar with this type of property. Also, financing is not always easy as many banks shie away from rental pools. Occupancy is, currently, 100% with a waiting list. What else? Oh yes... this property is uncommon also, because usually senior citizen housing is not held by small investors such as us; rather it is held by pension funds and insurance companies or certain REITS.

This is not intended as a sales task, my only benefit would be if everyone would rush out and the property would appreciate, which I doubt will happen. But it is certainly an example of a property in Calgary Alberta where you can still obtain very good positive cashflow. It is a great business. As always, DO NOT TRUST ME! Always and always check out the facts before you move on a tip. I just couldn`t resist to bring this to your attention.

$124,900 Whitehorn - 672, District B, 02 - Calgary, South, Alberta
Single Family ) Exceptional investment opportunity in this lovely suite located in whitehorn lodge seniors facility with onsite management and nursing. Monthly rental $1895.00. Amenities include: dining w/ 3 meals/day, theatre,craft rm & lounge/pub. Onsite bus with
$129,900 Whitehorn - 672, District B, 02 - Calgary, South, Alberta
D=6187924" target="_blank">

MLS®: C3287055 ( Single Family ) EXCEPTIONAL INVESTMENT OPPORTUNITY IN THIS LOVELY SUITE LOCATED IN WHITEHORN LODGE SENIORS FACILITY WITH ONSITE MANAGEMENT AND NURSING. MONTHLY RENTAL $1995.00. AMENITIES INCLUDE: DINING W/ 3 MEALS/DAY, THEATRE,CRAFT RM & LOUNGE/PUB. ONSITE BUS WITH For More Information

$129,900 Whitehorn - 672, District B, 02 - Calgary, South, Alberta

Exceptional investment opportunity in this lovely suite located in whitehorn lodge seniors facility with onsite management and nursing. Monthly rental $1995.00. Amenities include: dining w/ 3 meals/day, theatre,craft rm & lounge/pub.

 

[DonCampbell]

And that is why REIN Members in Calgary are smiling so much, they are now discovering positive cash flow again in their area.

Fundamentals and markets go through times of dramatic increase, rest, then increases again. Our estimate increase in Calgary for 2008 (as stated in the Calgary Herald) is estimated to be 12% (a much more realistic number than what we`ve been `enjoying` in the last few years.)

CONGRATS Godfried on discovering a niche that works for you in a city with such strong long-term fundamentals.

 

[LongWayFromHome]

You don`t need to choose between growth and cashflow. You really can have both. The so-called experts say you have to choose, but my experience is you can have both. I bought 14 properties in Canada this year. I didn`t really know Canada that well i.e. population, history, culture and industries of cities and towns. However, the Canadian RE opportunity is so amazing, that the results are pretty good - even though I was a complete Canadian Real Estate Novice. All 14 are rented. Gross returns are over 20%. (In my country, anything over 5% is considered a high cashflow property). The price growth on the 14 seems pretty good too. If I had to sell now, I think I would achieve well over 50% nett profit in less than one year. I have no intention of selling. I expect very strong price growth in years to come. The fundamentals of how to recognise a good city/town to invest in, select the right realtors to work with, select the right properties, negotiate really well and manage properties well are important. That is how you can achieve both capital growth and positive cashflow. No reason not to have both really.

 

[invst4profit]

House prices have historicly followed inflation. There have been times of unusual growth but otherwise fairly constant. As most know to make money in speculation one must profit going in or buy based on timing.
If I use my personal residance as an example I did everything wrong as an investment. I bought at market value, it stagnated for 6 years and now 25 years later it is worth 2X what I bought at.
That stinks. As a speculator I should have my privlages revoked. The initial cost plus payments, insurance, taxes, repairs, upkeep etc. has cost more than it is worth. Any good fund manager could have doubled my investment in less than 10 years.
The majority of landlords are the typical mom and pop type with one or two properties that bought under the assumption "real estate always increases in value". They fumble through ownership, seldom keeping good records of income and expences, and when they sell get more than they paid thinking they made money. The reality is they seldom if ever make money. They are poor business people for never realising they did not have positive cash flow and were poor speculators for relying on "real estate values always increase".
The question really is- Business or Speculation what is better?
The answer to the question isn`t about the money it is about the person.
I am a business person first not a gambler. My investments must pay me first not the banks. I am not so rich that I can afford to hold and gamble on the outcome of a future sale or even worse feed that gamble every month on top of my investment.
Cash flow is the life blood of any business. Appreciation is the bonus of a successful business..

 

[pamb]

I`m a newby. Just finished reading Don`s books. Have my bank package ready to go. Getting relationships established. Looking at economic indicators for various cities etc. Anyways I just finished reading this string and I`m so glad someone asked this question (cash flow vs cap gains). The books advocate both of course...but in practical terms this is very difficult (also mentioned in the books ie the perfect "skipping stone" analogy). It seems the consensus is positive cash flow is ok even if economic fundementals are not in place. Is this right? I suppose even if the property declines in value tenants are paying for it and then some so it`s money you wouldn`t have had otherwise (Rich Dad would like this). Am I on the same page as everyone else? If this is the case there are a ton of properties in the city of Winnipeg that generate positive cash flow....does anyone have any rentals in Winnipeg?

Also one person in this string made reference to interest only payments. My LOC, which will provide the down payment, is interest only and I was planning to do this with the balance of the investment properties mortgage (easier to get positive cash flow) until I read Don`s books. Question the 1.1 rule - does it apply to interest only too?

These may seem like silly questions to you pros out there but I`m a VERY cautious newby and would appreciate your help!

 

[Peter]

QUOTE (pamb @ Nov 22 2007, 01:32 PM) I`m a newby. Just finished reading Don`s books. Have my bank package ready to go. Getting relationships established. Looking at economic indicators for various cities etc. Anyways I just finished reading this string and I`m so glad someone asked this question (cash flow vs cap gains). The books advocate both of course...but in practical terms this is very difficult (also mentioned in the books ie the perfect "skipping stone" analogy). It seems the consensus is positive cash flow is ok even if economic fundementals are not in place. Is this right? I suppose even if the property declines in value tenants are paying for it and then some so it`s money you wouldn`t have had otherwise (Rich Dad would like this). Am I on the same page as everyone else? If this is the case there are a ton of properties in the city of Winnipeg that generate positive cash flow....does anyone have any rentals in Winnipeg?

Also one person in this string made reference to interest only payments. My LOC, which will provide the down payment, is interest only and I was planning to do this with the balance of the investment properties mortgage (easier to get positive cash flow) until I read Don`s books. Question the 1.1 rule - does it apply to interest only too?

These may seem like silly questions to you pros out there but I`m a VERY cautious newby and would appreciate your help!


The 1.1% rule is actually an underwriting principal used by lenders to evaluate the cashflow of a property, and based on that, approve or decline the mortgage. That particular principal at this time is only used by one lender - they will finance 75% of the purchase price and will allow an interest only payment, however only on one rental property. The remaining downpayment can come from your secured LOC, which would likely be an interest only payment at prime.

Depending on your personal financial situation, you may qualify for different mortgage prodcuts such as extended amoritizations and increased LTV`s. Extended amoritizations would give you the same benefit as an interest only payment in terms of repayment, but actually allow you to paydown some principal and have a lower rate mortgage.

Your broker should be able to recommend some different financing options for you but make sure they are aware of your long term investing plans so that they can apply a portfolio approcah and structure yoru financing from the beginning in a way that will allow to maximize your borrowing power.

Thanks

 

[EdRenkema]

Re the 1.1% I took a quick look in both books: 97 tips and REal Estate INvesting in Canada couldn`t find it, I`d like to bookmark it, can someone tell what section/page I can find this?
Thank you

Ed R

 

[Thomas Beyer]

right !

We market (to our investors): cash-flow and equity growth .. BUT: in order to have equity growth you need time, and thus you MUST have cash-flow to hold it !!!

 

[Thomas Beyer]

QUOTE (Peter @ Nov 22 2007, 01:59 PM) The 1.1% rule is ... Thanks


Actually, Peter, it is 1.1 or 110% rule (not 1.1%) !!

 

[carsonconn]

QUOTE (DonCampbell @ Nov 1 2007, 07:13 AM) There sure is. As a matter of fact, a number of Members have been doing very well in the area. They are using the filter system and focusing on `relationships` and are uncovering some VERY good deals. You may want to ignore the MLS and start looking at alternative sources. Once it has hit the MLS, others have already picked it over.

Duplexes and fourplexes are doing very well in both cities.


Condo`s are working out beautifully for me in Abbotsford and Agassiz, Chilliwack being centered between the two im sure you can find cashflow properties there as well.