Is my math wrong or are my expectations unrealistic?

[ReasonableDoubt]

Kfort,

Thanks very much for uploading your files. I love to see real world examples in action. Is it safe to assume it was worth seeing a small amount of negative cash flow at the beginning to get the property going and see it develop into positive cash flow?

 

[kfort]

I never actually had negative cashflow at that spot. I was very conservative on rents in those projections. Income was about $4-500 higher in total as I also did not include any garage income (against city bylaws so I consider it a temporary bonus until shut down).

Generally speaking, it made my car payments. However, 80/20 math applies and it has caused 80% of my headaches which I am only willing to put up with because of the ROI. Being on a sub-dividable multi unit zoned lot it has significant backend advantages also.

 

[DanPaarsmarkt]

$900 a Month for 20 Years...
By Ray Reuter

So, interesting story...stick with me for 5 minutes, you'll like this. I'm sitting around the REIN lunch room chatting about real estate (weird) and it was as if the sky opened up, the fog lifted and I had this epiphany...

"My worst case scenario... if I buy the way REIN teaches... is a free and clear asset... some years down the road... that my tenants bought for me."

I think I can live with that! Here is some super simple math showing exactly why residential real estate is so cool.

Let's say you go out and buy a single property TODAY for $300,000 (call it a suited house) and based on your conservative numbers, this property does nothing more than break even every month (and we're buying in a stable, well-performing market based on the fundamentals). No cash flow - just break even.

Then we're going to assume that the market will stay flat forever. We both know the market will go up, it will go down, but assume that over the next 20 years those ups and downs equate to a FLAT market...it's still worth $300,000 in 2033.
Still with me? Good.

Now over that 20 years the property just breaks even, nothing more, nothing less. Sure we've been up some months, but we've had some repairs & maintenance, some vacancy...so, over those 20 years we just break even. Some would call this a boring piece of real estate... even a 'non-performing' piece of real estate.

Call me crazy, but guess what, I call that a $900 a month savings plan that someone else (called my tenants) paid for.

That's right - after 20 years of holding this 'non-performing' piece of real estate I'm left with the equivalent of someone giving me $900 every single month for 20 years...I call that one heck of a savings plan.

Tell me, do you put $900 away every month right now? Maybe...but that's still YOUR money, money you had to work hard for! I'm talking about $900/month that someone gave me for the last 20 years, and it's mine...all from an unexciting, 'non-performing', piece of residential real estate. Want the math?

Here it is. I purchased for $300,000, I put 20% down plus closing costs, so roughly $65,000. In 2035, 20 years from now, I sell it for the exact same price...$300,000. I get my $65,000 investment back. I pay the Realtor and closing costs and I'm left with roughly $215,000.

That's with no cash flow, that's with no appreciation, that's simply my tenants paying down my mortgage (both principle and interest) for the last 20 years and leaving me with a free and clear property.

So $215,000 divided by 20 years = $10,750 per year. Divide that by 12 months = $896/month... that someone else gave me.

Sure we can calculate opportunity cost for your $65,000 investment, but tell me, would you be even mildly happy if someone, some stranger, was contributing even $500 a month into a savings plan for YOU & YOUR FAMILY for the next 20 years????

That's like someone else contributing to your RSP fund every month. You OK with that?? Of course! Go ahead and poke holes in it if you want...

"Ray, no one gets a 20 year mortgage!" OK, do you think with some strategic planning you can have this property paid off after 20 years...especially if you bank on no cash flow? I say of course!

"Ray, what about the roof, the furnace, etc???"

You're absolutely right. But let's be serious - over the next 20 years do you think my rent is going to go up or down? Do you think my property will be worth more or less in 20 years buying in a fundamentally strong area? Heck, even WHEN interest rates go up, guess what? So will my rent! This is a no-brainer.

Maybe...just maybe, this makes sense. Bottom line - real estate is simple...it's just not easy! And we're not talking get rich quick, we're not talking some 'sexy' investment strategy that 0.1% of investors ever pull off, just a simple old piece of real estate that you rent out and maintain for 20 years that YOU have 100% control over!

IT'S SIMPLE - I invest $65,000 to make $215,000 (before tax)...I'll take that all day long, and that's ONE PROPERTY. Now imagine if you bought 10 properties just like that over the next few years (which isn't rocket surgery).

It's the power of leverage, the power of having control of your investments, and the power of being in the business of putting a roof over someone's head (a business that ain't going anywhere any time soon!!!)

Think about it, read this a few times - this stuff works.

just noticed your point about no one gets 20 year AMs anymore. All but one of my properties is on a 20 year AM and all cash flow. I also like the idea that Sherilynn mentioned about prepayment. If you want to own sooner, do both of above.

 

[1050peter]

This is my first post on REIN. I think all new real estate investors should read this thread multiple times and I wished that I had read earlier. I'm about 5 years into taking real estate investing seriously, and only now am I seeing some properties generate fairly consistent positive cashflow. It seems to be a trade-off of buying turnkey properties (or hopefully turnkey properties!) with very low cash-on-cash returns, or you buy low/distressed and in poor condition, and every dime gets re-invested into the property. I've gone the latter route because I was willing to sacrifice short-term cashflow for preservation of capital, long-term capital appreciation, and eventual cashflow, but it takes a long time using $100/200 per unit per month profit to do upgrades. It's slow wealth generation. It gets easier in some ways with time, because I can juggle cash from one property to another as repairs are needed. I've also hedged geographically, figuring that I can't always chase the hot and cold property markets.

 

[Thomas Beyer]

Who told you there is cash flow in real estate ?

If you want true cash flow buy a REIT or any property with 60% or less leverage.

Cash flow is a function of leverage. If you pay all cash, with no mortgage, you can cash-flow all day long in most cities. 20% down deals with cash-flow in large cities are very very rare. Budget a more realistic 30-35% down for safe cash-flow. Cash-flow is usualy re-invested into the asset for upgrades or to bridge vacancies. So a $200/month cash flow for 24 month, or roughly $5000 can easily be swallowed in a 1-2 month vacancy plus new appliances plus new carpet.


Cash flow allows you to hold and pay the mortgage down while the banked cash is used for vacancies and occasional upgrades.

Let's say you put 25% down. Asset values goes up 10-15% in 5 years for a 40-66% cash on cash ROI in five years plus mortgage pay down of another 35% or so of the cash invested ( or 12% of 75% divided over 25%) so 75-100% cash on cash in 5 years.

Assured wealth creation basically unless you must sell earlier or cannot hold. Better ten years due to the enormous buy/sell transaction costs like legal fees, appraisals, inspections and realtor fees.

Real estate is not a get rich scheme - it is a get rich for sure scheme !

More here: http://myreinspace.com/threads/what-is-better-cash-flow-or-higher-roi.26596/

 

[1050peter]

Totally agreed. I actually aimed to make positive cashflow off the bat, knowing that there would be hidden costs and I'd really break even when all was said and done. And that has been more correct than I was hoping! I'm very happy with how things are going. But the high frictional costs and inevitable deferred maintenance costs mean the first 3-5 years and maybe more will be impacted (my time horizon was 5 years to see some results and 10 years for a major payoff). Flipping and speculating can work, but it's a game I won't play. With buy and hold, it's a bit forgiving if you pay too much on your first deal or two (and I probably did by a bit). With a flip, it can be a disaster.

 

[Rickson9]

Confusing post.

"aimed to make positive cashflow off the bat" ...

"knowing there would be hidden costs" ...

"I'd break even" ...

Also don't agree that buy and hold is inherently better than flipping. Why against flipping? It's all arithmetic. The math works or not.

If you suck at arithmetic then buy and hold is 10 years of nothing. I don't see how that's inherently better than a short-term flip if the numbers are better?

 

[1050peter]

I think you read in too much. I didn't say that flipping is worse than buy and hold - it all depends on your goals, your experience (e.g. are you a contractor or real estate agent), time horizon and market that you work in. I've actually done slow flips (buy, live and sell in 3-5 years) and done well with it, because I could add value. The context goes back to wondering about properties generating positive cashflow early and what to expect. Thomas's point is exactly my experience that returns in a buy and hold often take time to bear fruit. My point about costs is that, particularly in the beginning (and I'm still going through a big learning curve), most people will make mistakes such as underestimating renovation costs and expenses, particularly if they buy an older building. I've even seen very large owners (I'm referring to REITS and large corporate owners) make these mistakes even after getting specialist advice. Overestimating revenue can also happen. 'Hidden' is perhaps the wrong word - it's more what was missed in the analysis of the deal. So I aim not to break even, but make a bit of money each month as a buffer, knowing that if I aim to break even, I'd probably lose money instead because I didn't get my risk measured correctly.

Let me clarify about flips. A flip (well, any real estate deal) has fixed 'frictional' costs - legal fees, taxes etc. so the flip has to be profitable enough to cover these costs. Plus the property typically has to carry with no revenue coming in, and a market can go 'cold'. With a long term buy and hold, the fixed costs are absorbed over years, there's usually income coming in from Day 1, and with a long-term horizon the property cycles matter a bit less. I'm not sure if I totally agree with the word 'assured' but there is something to be said for taking a long view of having tenants pay your expenses including your initial costs. And that was also my read on Thomas's comments. So, if the math works, including factoring in risk, I say go for it - flip, buy hold or whatever.

 

[Rickson9]

I get it now. Thanks.

 

[Matt Crowley]

^^ Exactly Peter. You will never find a developer who can't make a pro forma look good.

 

[Rickson9]

That's why we have telephones and the ability to communicate

 

[Matt Crowley]

It's not that simple Rickson9. The biggest developers get this wrong. Pro formas never happen and are always wrong. They are just (very worthwhile) plans.

Some of your pithy comments I think miss the complexity, nuances, and grey area of real estate development. Which is as much a science as an art.

For example: $/SF. Do tenants look at usable space? What about the value of 9' vs. 10' vs. 8' ceilings? Should we look at a $/cubic foot? What is an 'optimal layout'? Obviously $/SF is highest for bachelor suites so why not just build buildings with only bachelor units? The industry is not that simple. Not even close.

 

[Rickson9]

I don't trust pro formas either. Ignore them actually. If pro formas 'always wrong' then that is useful information. How to make them less wrong? Objections always have solutions.

Telephone and conversation is useful. Who just calls the 1 developer? Your phone only dials 1 number?

Pithy comments aren't. Lot of nuance behind words. If one chooses to see them.

Most problems can be solved by a low purchase price. If not, then price needs to be lower.

 

[RE123RE]

If you suck at arithmetic then buy and hold is 10 years of nothing. I don't see how that's inherently better than a short-term flip if the numbers are better?

Hi
Nice one, you can say anything here _______ and then add "if the numbers are better", and you will be correct
Have you considered the fact refinancing is TAX FREE and flipping is not?
Reminding you also that when you sell you stop paying down your principal. - a very important (and surprisingly confusing) wealth building strategy people often ignore (to be polite), ok don't get (to be honest).
Thanks

 

[Matt Crowley]

I don't trust pro formas either. Ignore them actually. If pro formas 'always wrong' then that is useful information. How to make them less wrong? Objections always have solutions.

Telephone and conversation is useful. Who just calls the 1 developer? Your phone only dials 1 number?

Pithy comments aren't. Lot of nuance behind words. If one chooses to see them.

Most problems can be solved by a low purchase price. If not, then price needs to be lower.

Your comments are so obvious they make me laugh sometimes. Geez. You think you are the only professional in this blog? Good grief.

Professional companies that own a LOT of real estate create pro formas. All of them. They are useful to frame the conversation. But they are totally iterative. It is more about understanding the assumptions that got you there than hoping it comes true down to the dollar.

Not to say you don't know your stuff. It is just a bit blowhard.

 

[Rickson9]

At my level pro formas are worthless. At my level they're marketing documents.