What is better: cash-flow ... or higher ROI ?

CorySperle

Senior Forum Member
REIN Member
[quote user=therenoguy]Personally, I'm all over the cash flow option. I'm currently in a high asset, low cash flow situation(which I'm slowly changing), and let me tell you it truly sucks.


I agree with this. Can you elaborate on how your slowly increasing your cash flow?
 

CorySperle

Senior Forum Member
REIN Member
[quote user=RedlineBrett]I would put my retired parents in a cash flow rich, equity poor investment structure.


I would say the same for my parents as well but cash flow rich, equity poor investments seems tough to come by these days. Can you provide an example of an investment that would provide this?
 

Thomas Beyer

Senior Forum Member
REIN Member
It makes sense to borrow at 2.2% ( with CMHC ) to 3% ( without CMHC ) if the asset yields 5% or more. You can get higher yielding assets with less "real" security, such as second mortgages, syndicated car loans, credit card receivables, manufacturing lending or factoring, but you cannot borrow much against it, the loan interest rate would be far higher and the risk is also not as low as well selected, well managed, well located real estate. As such real estate makes sense on both sides of these opposite scenarios: sensibly levered due to cheap credit, or as ultra safe, but lower return investments unlevered, or in between, depending on one's world view of risk, real estate, inflation and other assets' yields.
 

Thomas Beyer

Senior Forum Member
REIN Member
Why is cash flow better ? Cash flow has to be seen in light of the remaining value of the equity. If you get cash-flow but the remaing equity is flat, or depreciates, that is not better than having little or no cash-flow but appreciating equity. Similar to some REITs or dividend paying stocks: getting 5% a year in distributions or dividends but having REIT or stock drop 10% annually in value is worse than no cash-flow in a flat REIT or stock !
 

RedlineBrett

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Private second mortgage companies.... lend at higher rates, but your money does not appreciate while it is loaned out. Sorry for the late reply.
 

RedlineBrett

Senior Forum Member
REIN Member
I think everyone loves income. (how is that for insight!)



Because of that, the value of investments that throw off a lot of cash is very high, which drives up the price people are willing to pay for them, which then reduces the dividend % when compared to acquisition price.



I feel that's why yeilds on real estate have largely held similar spreads for 10 years or so.



The best way is still to own your own hard real estate asset in a growth market manage it well to maximize income and reduce expenses.
 

Thomas Beyer

Senior Forum Member
REIN Member
[quote user=Darr]RENT and buy gold and gold stocks.
perhaps this isn't such smart advice with gold prices down almost 25% since the beginning of the year, and rents up in almost all Canadian, European and US cities due to tighter, more normal mortgage under-writing requirements.



BUY if you envision living there a long time. Rent if length of living there is short, or unknown.



Buying a building with sensible leverage that cash-flows is better than gold, as it provides not just an inflation hedge like gold but also provides income and societal benefits. It's like gold with a yield.



I don't buy into all this "hyper inflation" BS in industrialized nations. Maybe in Egypt, Iraq or Zimbabwe. Not in the western world.



Buying sensibly levered makes total sense to me. Like Goldi-Lock: not too high, but not too little either ! Just right ! "just" is in the eye of the beholder and a function of risk tolerance, cash-flow needs and age !
 

Darr

New Forum Member
Registered
[quote user=ThomasBeyer] I don't buy into all this "hyper inflation" BS in industrialized nations...Not in the western world.


This reminds me of a few old sayings:

- When you`re one step ahead of the crowd you`re a genius, when you`re two steps ahead, you`re a crackpot.

- The early bird gets the worm.

- I skate to where the puck is going to be.



About industrialized countries; the pound was devalued by 30 per cent on September 18, 1949 and again in 1967 by another fifteen percent. Moreover, as a result of the collapse of Bretton-Woods on August 15, 1971 most countries suffered massive inflation in the 70's but the UK was one of the hardest hit.



Priced in USD, gold rallied from $35 to over $800 in less than a decade. Real estate in Canada was up 50% in three years from 1972 to 74. Only the gullible believe that oil was up as result of OPEC. Everything was up: oil, gold, R/E, wheat, cotton, etc. The untold truth is that the currencies got devalued because of growing deficits.



Anyone who thinks, even for a moment, that a currency confidence collapse cannot happen in our western world is ignorant of current monetary policy and monetary history in general. All central banks are linked. If one currency goes such as the Yen, the Pound, or the USD then all currencies will be devalued to maintain relative parity. Even Canada will feel the outer winds of a global currency debasement. It`s actually happening right now and accelerating.



Notice that the prices of things you need are rising while the prices of things you want are falling. Discretionary income is fading and cash is being allocated to staples.



Although yields will be suppressed to prevent governments from falling off the fiscal cliff, banks will not lend in such an environment and credit issuance standards will be prohibitive. Watch-out at renewal. May fortune favor the foolish.
 

Thomas Beyer

Senior Forum Member
REIN Member
[quote user=Darr] ... global currency debasement. It`s actually happening right now and accelerating.

...

That's why it makes sense to own or buy hard assets with a yield, and lever appropriately. If you can borrow at 3-4% and invest at 5-7% then this makes total sense to me.



[quote user=Darr]banks will not lend in such an environment and credit issuance standards will be prohibitive. Watch-out at renewal.
fair enough .. hard asset lending is one of the most preferred loans for banks as the risk is lowest, and as such we may not see 80%+ lending like we used to but 65-70%+ like we have seen for decades.



Looking at our own balance sheet, we have dialed down the leverage from a usual 85% in the 2000-2005 timeframe (with very high cash-on-cash ROIs in a market that was increasing in value at 7-10% a year) to a more modest 60-70% today with associated more modest (but likely safer) cash-on-cash ROIs.



Without a mortgage the cash-on-cash ROI is lower - and yes, with less risk. The point of my blog post here is that mortgaging an income producing asset increases the ROI. The investor/owner of the asset determines the risk they wish to take: 0% leverage, 25%, 50%, 75% .. their choice !
 

Darr

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[quote user=ThomasBeyer]The investor/owner of the asset determines the risk they wish to take: 0% leverage, 25%, 50%, 75% .. their choice !
Those numbers are nice, but a 50 percent down payment represents 100% leverage.

A 25 % down payment represents 300% leverage. 15% down equals 566% leverage.

Somebody`s going to get hurt real bad.
 

Thomas Beyer

Senior Forum Member
REIN Member
[quote user=Darr]Somebody`s going to get hurt real bad.
or not .. if you invest in growth markets with in-migration or job growth.



As I said risk is higher with higher leverage as markets do not always go up, or if they go up as they usually do on average, not in a straight line, i.e. it wobbles along an inflationary upwardly sloped line. As such be aware of the risk, and have appropriate reserves if highly levered.
 

Darr

New Forum Member
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[quote user=ThomasBeyer] and have appropriate reserves if highly levered.
This I agree with wholeheartedly.

However, I also believe that most levered borrowers do not have such reserves.
 

TangoWhiskey

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You define appropriate reserves as three months mortgage, utilities, expenses and taxes? Or more? Six?
 

Thomas Beyer

Senior Forum Member
REIN Member
Complex problems have simple, easy to understand wrong answers.



reserves depend on:



  • required and known upgrades
  • likely required, but unknown deficiencies
  • not required, but planned upgrades for increased value and rents
  • risk tolerance of the operator
  • risk tolerance of the operator's partners, incl. his/her spouse
    cash-flow / income from other assets
    age of the asset
    volatility (i.e. vacancy history) of the city
    cash-flow from this asset
    ability to absorb a loss if asset is sold prematurely or below purchase price
 

Thomas Beyer

Senior Forum Member
REIN Member
[quote user=TCarter] In scenario #1 I don't see how a third of his mortgage payment went towards the principle. The way I understand mortgages less than 10% of his monthly payments would have gone towards the principle for the first 5 years. Is this the result of a low interest rate or is his mortgage structured differently?


The numbers are rough estimates only to show the principle in general, assuming a 25 year, not 30 year amortization as is common in commercial mortgages (as opposed to residential where 30 years is more common). A $3M mortgage in scenario one is actually about $190,000/year and at 4% interest $120,000 is interest payment in year 1 and $72,000 is principal paydown in year one, with numbers slightly higher per year on the principal side. With CMHC today you can mortgages around 3% and you'd pay less overall per year and you'd pay more principal down, roughly 14% in 5 years.
 

Thomas Beyer

Senior Forum Member
REIN Member
[quote user=Darr]Watch-out at renewal.
Fair enough. But by renewal time you have paid your mortgage down 12-15% and the asset value and rent is likely higher. Also, if your mortgage is CMHC insured auto-renewal is guaranteed.
 

Darr

New Forum Member
Registered
[quote user=ThomasBeyer]

Also, if your mortgage is CMHC insured auto-renewal is guaranteed.





That's interesting new info but the devil is always in the details.

Can you provide more info and a link to this "auto-renewal guarantee" per your comment?
 

Thomas Beyer

Senior Forum Member
REIN Member
CMHC insures loans for banks. It reduces the risk to banks to zero. As such they

a) can lend to you at low low rates, and

b) don't have to count it under Base III rules as risk capital, and thus

c) trip over themselves to lend you money .. currently 2.6-2.8% for 5 year money



CMHC insures loans for 25 years, 30 if you pay 0.5% extra upfront. As such this loan insurance is valid for 25 years years, and then 20 more once your 5 year term is up. We are doing such a renewal right now for an asset we own in Camrose, AB.
 

coolaj

New Forum Member
Registered
I would say I would choose somewhere in between 1 and 2



Why:

I am a true believe that there should be a small cashflow from any deal. And the same time I always maximizing the leverage in terms of mortgages that I have. So 0 cashflow does not work for me personally.

I would probably create another scenario:



Scenario 1b:

Ã$1M invested, $3.5M asset, 6% CAP (yield), 80% LTV (loan-to-value) mortgage at $2.8M at 4%


$210,000 NOI (net operating income) minus

Ã$172,000 mortgage payment (of which $60,000 is principal and $112,000 interest)

Ã$72,000
`cash-flow` in theory .. Some of which will be asset management fees,
annual accounting, tax filing costs, overhead (say $20,000) and rest
upgrades (say $40,000) .. $12,000 per year or 60,000 in 5 years.



Ã20% value growth in 5 year to $4.2M due to inflation and upgrades/rental upside (4%/year on average)



ÃEquity in 5 years: $700,000 gain plus $300,000 mortgage paydown + 60,000 in cashflow = $1.06M =

Ã

Ã106% ROI (return on investment)



in 5 years ..
 

vnwind

Inspired Forum Member
Registered
One thing I am not fully understand when looked at Scenario 1 is that you assume the house price appreciate over 5 years, what if it depreciate or even out over time then cashflow may be a better option?
 
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