Positive Cash Flow

[Merriora]

Hello

I`ve been through all the threads I could find on Cash Flow, but did not find an answer to the following...

When discussing Positive Cash Flow, do investors consider the LOC payments as part of their calculations or does everyone calculate Cash Flow based on:

- 25% Down Payment (any interest on money for Down Payment not considered)
- 25 year ammortization

With the option of putting as little as 10% Down Payment and stretching a mortgage over 40 years, a negative Cash Flow can easily become positive, but the return (equity accumulated) will be a lot less.

1. Is LOC payments considered as part of Cash Flow
2. Do investors use the above standard to calculate Cash Flow or simply work the numbers (amortization period, down payment amount)


Thank You

 

[bonniemersereau]

I include LOC payments ( interest only) in my cashflow analysis as it is cash out of my business.

 

[RedlineBrett]

QUOTE (Merriora @ Dec 12 2007, 03:57 PM) Hello

I`ve been through all the threads I could find on Cash Flow, but did not find an answer to the following...

When discussing Positive Cash Flow, do investors consider the LOC payments as part of their calculations or does everyone calculate Cash Flow based on:

- 25% Down Payment (any interest on money for Down Payment not considered)
- 25 year ammortization

With the option of putting as little as 10% Down Payment and stretching a mortgage over 40 years, a negative Cash Flow can easily become positive, but the return (equity accumulated) will be a lot less.

1. Is LOC payments considered as part of Cash Flow
2. Do investors use the above standard to calculate Cash Flow or simply work the numbers (amortization period, down payment amount)


Thank You

If you are borrowing the down payment then yes, you need to include the cost of servicing that debt. You are basically 100% financing the property with that strategy.

Cash flow is measured as the total revenue-total expenses. You can get better cash flows by going with a longer amortization however it will take you that much longer to pay off the loan.

 

[George]

Good evening,

Cash is King. If its gone, its gone, regardless of exactly what it was spent on.

I`m cautious of what some people call cash flow in that if I pay cash of 100% of the asking price, clearly I should have a little cash flow. I think that it is artificial to say that by increasing the deposit I increase my cash flow. In my mind there should be an "opportunity cost" of cash calculated when considering an investment. In other words, what could I otherwise earn with my hard cash if invested elsewhere. That`s not to say I wouldn`t make an investment where the total cash flow and opportunity cost would result in a negative return, but I`d want to be very comfortable with my return from principal repayment and appreciation.

Just my two cents which I expect will be an unpopular opinion.

Warm regards...

George

 

[terri]

QUOTE (George @ Dec 12 2007, 06:33 PM) Good evening,

Cash is King. If its gone, its gone, regardless of exactly what it was spent on.

I`m cautious of what some people call cash flow in that if I pay cash of 100% of the asking price, clearly I should have a little cash flow. I think that it is artificial to say that by increasing the deposit I increase my cash flow. In my mind there should be an "opportunity cost" of cash calculated when considering an investment. In other words, what could I otherwise earn with my hard cash if invested elsewhere. That`s not to say I wouldn`t make an investment where the total cash flow and opportunity cost would result in a negative return, but I`d want to be very comfortable with my return from principal repayment and appreciation.

Just my two cents which I expect will be an unpopular opinion.

Warm regards...

George

I totally agree with you George,

I use my line of credit as my downpayment and I have to take teh interest on that line of credit into consideration so I do all my anaysis at 100% financing. If it doesn`t cash flow or at least break even, I can`t afford to buy it.

Terri

 

[Thomas Beyer]

cash-flow .. over what period of time ?

frequently a building or house needs work upfront to become rentable or to increase rents .. so often cash-flow is negative in the first few months (or 12-18 months in case of an apartment building which is the area we specialize in) .. but then the rent is up and it cash-flows nicely .. and can be sold or re-financed based on a higher income .. as income properties are based on a multiple of the income it can generate ... so cash-INflow and cash-OUTflow planning over the life of the project is key .. so often if we need $2,000,000 to buy an asset we raise $2,400,000 or slightly more to cover upgrade costs, negative cash-flow, acquisition fees, mortgage commitment fees ..

We`ve made 100`s of thousands of $s in asset that did not cash-flow from day one .. but we had enough cash in the bank to cover it until the cashflow improves .. then we frequently re-finance .. pull out all or most of the invested money .. and then your cash-on-cash ROI is quite huge (i.e. no cash invested anymore ..)

so while cash-flow is required to own long term, CASH is indeed king to buy and upgrade and hold ..

usually we pay our co-investors all their money back (after our fees) from re-fi or cash-flow .. so essentially 0/100 .. and only when they have all their money back we usually do 50/50 .. this works with $10,000 or $800,000 or $2,400,000 ...

 

[invst4profit]

Many landlords seem to have trouble defining positive cash flow. I see adds all the time for properties for sale declaring positive cash flow. I don`t know what numbers they are using but there numbers seldom show positive cash flows in the real world. I call their calculation the Golden Goose formula, assuming each property comes with a Golden Goose to supliment the rental income there by creating positive cash flow.
Equity Accumulation and return on investment (down payment) have nothing to do with positive cash flow.

My formula is reasonably straight forward. First my calculations are always based on 100% financing. My money never works for free so down payment is never discounted in the formula.
Take the monthly rent, divide by 2 (monthly expences = 50% of rent) subtract debt repayment based on 100% financing (purchase price plus closing costs plus initial repair costs). Anything left over is what you can expect as positive cash flow on a ongoing basis.

Now I know many people will say that formula will never produce positive cash flow on there property and the reality is they will never see "true" positive cash flow. What they will see is a sea saw effect of good months and bad months ( good years, bad years) that at any given point in time may "appear" to show positive cash flow..

 

[RedlineBrett]

QUOTE (invst4profit @ Dec 13 2007, 08:50 AM) Many landlords seem to have trouble defining positive cash flow. I see adds all the time for properties for sale declaring positive cash flow. I don`t know what numbers they are using but there numbers seldom show positive cash flows in the real world. I call their calculation the Golden Goose formula, assuming each property comes with a Golden Goose to supliment the rental income there by creating positive cash flow.

I have seen these adds too. I`m sure what they mean to say is "It`s cashflowing for me!"

 

[jarrettvaughan]

QUOTE (RedlineBrett @ Dec 13 2007, 08:47 AM) I have seen these adds too. I`m sure what they mean to say is "It`s cashflowing for me!"

I think that you are exactly right Brett. These landlords are reffering to the fact that they bought the property 10 years ago for $60,000 and have a very small mortgage. They are not taking into consideration the fact that the new buyer will have a much larger mortgage with similar revenue generation oppertunities.

 

[invst4profit]

Owners holding properties for an extended period of time need to be aware of the fact that property values have increased considerably over the past 10 years and need to be diligant in raising there rents as much as possible to assist in resale. Unfortunatly some areas here the values have risen so fast in the past 5 years that rents have not kept up (rent control) and owners are trying to sell above a positive cash flow level. Inexperienced investers (not REIN members) are jumping in and getting burned when they underestimate expences.

 

[AlanHunt]

I only count the costs which are directly associated with the property - ie secured against title.

I do not consider the cost of borrowing for my JV partner for the cash they put into the deal

 

[Thomas Beyer]

QUOTE (invst4profit @ Dec 13 2007, 08:50 AM) ....

Take the monthly rent, divide by 2 (monthly expences = 50% of rent) subtract debt repayment based on 100% financing (purchase price plus closing costs plus initial repair costs). Anything left over is what you can expect as positive cash flow on a ongoing basis.

..

This is an excellent rule of thumb to analyze assets that we also use. Given relative low interest rates, one can get better cash-flow these days .. but the prices are usually higher (i.e. low CAP rates) for that same reason ..

One major issue is that a large part of the cash invested is for inital or ingoing upgrades, thus allowing higher rents, thus allowing higher value .. and as such one can`t just ignore these capital improvements (also called Cap X or Capital Expenditures) .. yes they eat into cash-flow .. but they increase value ..

We use this 2nd rule of thumb: Rule of 100 (to 150) monthly NOI times 100 (i.e. 10% CAP) or times 120 (8.25% CAP) or 160 (6% CAP) is the value of the asset. So, if I can increase my rents / NOI $100 because of a new carpet and fridge that cost me $1000 + a friendly / trained onsite manager , the asset value / suite goes up $12,000 to $16,000 .. is this not a good investment of $1000 ? This is where the true money is made in income producing assets .. and to materialize this gain in value I have to sell it or re-finance it ..

Hence: cash-flow AND equity growth is desired and achievable (and marketed and exploited by us as capitalistic/opportunistic/ethical/socially conscicious investors) .. focusing solely on cash-flow is an operational survival issue, but not a wealth creation issue !

 

[Merriora]

Thank you to everyone for your input and thoughts at this matter.

As posted above, I have seen ads mentioning positive cashflow, but then I look at the selling cost and can`t see how it would be positive without 25% Down Payment.

This clarification will keep me on the right track.

 

[invst4profit]

That is the trick that catches many inexperienced investers into thinking they have positive cash flow when in fact they do not..
Be carfull about falling into the misconception that a larger down payment assists cash flow. That would only apply if your money was worth nothing to you in the first place. Yes if you kept your money under your mattress earning no interest than using it to pay down your morgage would assist cash flow. No invester I know does that. They have there money invested easily earning 10%+ even in mutual funds.
I personally prefer to borrow from the bank at 6-7% than borrow from myself at 10%.
This is the reason why I use a calculation based on 100% financing even if part of that is my own money. This gives me my True positive cash flow calculation not one that has been "forced" to cash flow by manipulating the numbers like too many new investers try to do.

 

[navaz]

now for my two bits worth- cash flow is a relative term. It is relative to how much greif it is causing you and what your long term plans are.

Firstly, what do I mean by relative? Lets say you earn $100K per year. One of your properties has a negative montly cash flow of $200 -not enjoyable but you can handle it. Alternatively, we get a tenant that causes damange, a property manager that fails to rent the unit out -costs $5 K to fix the damage one time -your years cash flow is gone -not enjoyable but we can handle it. Alternatively, a family with $30K of income -this will be deadly.

Next is to look at your objective -if it is to earn $10K per month 10 years from now -do your analysis upfront, sometimes we will buy a property that will have negative cash flow the first year or two, rents will catch up, tenant profile will change, deferred maintainance will be taken care of -now in year two or 3, you will have positive cash flow.

If you cannot take a long term approach, this is a wrong game for you because you are going to hit different scenarios and you will get nervous early in the game.

 

[RedlineBrett]

QUOTE (invst4profit @ Dec 14 2007, 07:19 AM)
That is the trick that catches many inexperienced investers into thinking they have positive cash flow when in fact they do not..

Be carfull about falling into the misconception that a larger down payment assists cash flow. That would only apply if your money was worth nothing to you in the first place. Yes if you kept your money under your mattress earning no interest than using it to pay down your morgage would assist cash flow. No invester I know does that. They have there money invested easily earning 10%+ even in mutual funds.

I personally prefer to borrow from the bank at 6-7% than borrow from myself at 10%.

This is the reason why I use a calculation based on 100% financing even if part of that is my own money. This gives me my True positive cash flow calculation not one that has been "forced" to cash flow by manipulating the numbers like too many new investers try to do.




If you make a larger down payment your money certainly isn't dead - it is being used to secure an appreciating asset that (hopefully) cash flows. The trade-off is that the more money you put down the smaller your returns are $ for $. Cash is a commodity in this business - The name of the game in long term real estate investing is to use what cash you have to get you into as many cashflowing properties as possible.



When we skin a deal we put actual numbers to everything. Borrowing costs, taxes, repairs, vacancy, insurance you name it. What that allows us to do is see the cash on cash return we are getting for our invested capital. Every deal then has an ROR attached to it - the better the ROR the better the deal... the best deal gets the cash simple as that.



At that point you can compare apples to apples. If I have a property that will return 20%/year or a mutual at 10% it's an easy decision and that's the picture we like to paint for our investors. The danger to using 100% finance is that you are then introducing another variable to the equation - what else that money would be doing for you or the opportunity cost of capital. Every potential JV partner is different so we choose not to do it that way. We show them what we can do with their money and leave it up to them to decide if it's time to cash in that RRSP, GIC or take a second mortgage.

 

[timk519]

For calculating if a property is generating a return or not, does anyone include the mortgage paydown in their calculation?

I`m assuming cash flow is money in your pocket at the end of each month, not including principle payment.

 

[GarthChapman]

First there is Cashflow
And there is Mortgage Paydown
The total of the two is (in the REIN vernacular) `Cashflow Plus`, and that is your certain ROI.

Then there is Value Appreciation, which is an unknown but can be estimated. This is this the icing on the cake, so to speak. And,onceknown, it is the total ROI.

Hope that helps,

 

[jugasolo]

Hey Navaz



I found your contribution in the blog tonight as I was looking for further clarification regarding the 10% rule and the positive cash flow. I started working with realtors in a few other cities in Canada and the US (Regina, Edmonton, Calgary, Middletown-Wi and Madison-Wi) to get an idea of the opportunities. In most cases it would be hard to achieve the positive cash flow in the first 2-3 years as I will be borrowing 100% of the cost either from LOC or mortgage.



I agree with your answer though. It is relative to how much you can handle if the conditions change (e.g. interest rates go up) and how much are you expecting to make from the appreciation of the property. Ideally it is positive from the start, but not sure it is always possible.








QUOTE (navaz @ Dec 14 2007, 09:24 AM)
now for my two bits worth- cash flow is a relative term. It is relative to how much greif it is causing you and what your long term plans are.



Firstly, what do I mean by relative? Lets say you earn $100K per year. One of your properties has a negative montly cash flow of $200 -not enjoyable but you can handle it. Alternatively, we get a tenant that causes damange, a property manager that fails to rent the unit out -costs $5 K to fix the damage one time -your years cash flow is gone -not enjoyable but we can handle it. Alternatively, a family with $30K of income -this will be deadly.



Next is to look at your objective -if it is to earn $10K per month 10 years from now -do your analysis upfront, sometimes we will buy a property that will have negative cash flow the first year or two, rents will catch up, tenant profile will change, deferred maintainance will be taken care of -now in year two or 3, you will have positive cash flow.



If you cannot take a long term approach, this is a wrong game for you because you are going to hit different scenarios and you will get nervous early in the game.

 

[gwasser]

When I invest my own money to generate cash flow (by balancing down payment versus mortgage principal), I look at several criteria. For me as a retiree, monthly cash flow is important so I only invest if it adds to my income from stock dividends, GICs, Bonds and other rental properties. In addition to generating cash flow, I use the Down payment/principal balance to have a safety cushion in case property values fall - they do!

Secondly, I look at the return on my equity, i.e. cash flow plus estimated appreciation over the coming years (mostly year one and two) compared to my total cash investment. I look only at the first couple of years because they are financially toughest; once they give me 10 to15% total return I know they will keep on doing so or better for later years without me having to worry about adding further cash. Future rent increases are difficult to predict but just like dividend increases they provide inflation protected income and sometimes even better. For estimating future appreciation, I usually take the inflation rate which is somewhat conservative but it does the job for me - I consider 8% appreciation way too aggressive but don`t mind making it in real life! Andrei Angelkovski recently posted on this forum the long term appreciation of real estate in various cities of Alberta and Eastern Canada showing rates of 6 to 7% and this includes the 1980`s when we had double digit inflation.

Investing my own money as equity in a property versus a mortgage also depends on how much cash I have on hand and where I can get the best return in comparison to risk incurred. When I have a lot of cash, rather than rushing out and buy new investments I consider on an after tax basis what is better: reducing my mortgage payments or put the money in a GIC. Paying of the mortgage wins it every time hands down.

I look at real estate as something that is part of an overall investment portfolio. I like real estate because it let me set the risk level I want to be exposed to by playing with the equity/principal balance. Stock and bonds are way too volatile for doing that. Overall, I am very happy with a total annual investment portfolio return of 10 to 15%. Real estate CURRENTLY easily makes those targets. And the longer you own a property the easier it gets.

There is another advantage to playing real estate conservatively. When I need a loan, people jump! Today I am signing the papers for another unit in Whitehorn (see my posts earlier on this forum). Next month, I am looking to take advantage of Don`s Calgary Transportation Report and I`ll buy an older 2 bedroom apartment near downtown Calgary. I thought Don`s review of new Condos in Downtown Calgary was superb and this seems to be the perfect time to take advantage.