If you’ve watched any RealWealth property team webinars recently or you attended our event in Florida last month, you may have noticed a big change in the last year or so: cash flow is not what it used to be.
A $150,000 property you purchased three years ago might have generated $350 or more per month in cash flow in year one. Today, that same property costs closer to $250,000 and the cash flow is closer to $100 to $150 per month.
Many experienced investors might be asking themselves why on earth they should continue to buy investment property today when they can invest in lower-risk stocks like Apple and Amazon, bonds or CDs. Newbies who have never invested before may be even more confused, because the numbers just don’t make obvious sense like they used to.
To get some insight on this article, I spoke with RealWealth’s investment counselors, who are all experienced real estate investors.
Here’s why they believe buying investment properties is still a great investment today…
Is cash flow dead? A pro forma example.
To answer the question about whether cash flow is dead, I’ll use a sample property pro forma from Jacksonville that I screen shotted from the RealWealth Realty Portal.
As you’ll see, if you were to finance this property, your initial investment would be just under $60,000 and your monthly cash flow would only be $85 per month after your mortgage, property management expenses and insurance.
(Note: this is an extreme example of a property with very little cash flow. There are definitely opportunities to buy investment property at a similar price point that produce about $150 per month in cash flow.)
4 Reasons To Buy Rental Properties with Low Cash Flow
#1 - Most of your returns come from appreciation
If you buy a house in Florida worth $250,000, you can expect it to be worth $350,000 in ten years. This means that your equity has gone up by $100,000 (not counting your principal paydown).
If you’re generating $100 per month in cash flow over those ten years, you’ll also make $12,000 in passive income. $100 x 12 months x 10 years = $12,000. (Something to note is that rents go up with inflation, so the $12,000 is in today’s dollars. You’ll actually end up making more.)
As you can see, the property’s $12,000 in cash flow over ten years pales in comparison to the appreciation gains of $100,000.
Your mindset is to buy an appreciating asset that generates enough cash flow to cover the expenses while it’s appreciating. You plant the seed today (by buying the property) and just wait.
If you follow RealWealth investment counselor Joe Torre’s “10-10 plan” (buy 10 houses in Florida or similar market and wait 10 years) your net worth will increase by $1 million. (Again, this is not counting principal paydown).
By then you won’t remember that you only got $1,200 in cash flow in year one.
#2 - Real estate preserves capital during high inflation
During periods of high inflation, like right now, stocks and bonds perform poorly overall.
Inflation is great for real estate assets, because it causes rents and property values to go up even faster. Plus builder’s costs go up during periods of inflation, so the replacement cost of your real estate gets higher and higher.
If you want proof, just ask your parents and grandparents. Investors who bought real estate in the early ’70s did very well. The common lament is “I should have bought more….”
What’s important to note is that traditional cash flow markets like Indianapolis and Cincinnati have seen, and will likely continue to see, price appreciation during periods of high inflation. Meanwhile, you’re paying off your mortgage with inflated and devalued dollars.
#3 - Cash-on-Cash return is the WORST in year one
What many new investors don’t realize is that cash-on-cash returns are the worst in year one and then they just improve from then on.
The rents are at their lowest level during the year after you buy a property and they increase overtime while your mortgage payments remain generally fixed. Also, year one is when you have to pay for closing costs – a one-time expense – so cash-on-cash return in year one will be at its worst.
As long as all of your monthly costs as an owner can be covered in year one, the cash flow will likely get better from then on, especially with demand for rentals being as strong as it is.
Also, many of the property teams we work with are now offering 5/1 Adjustable Rate Mortgages, with lower rates that are fixed for the first five years. This can help with cash flow in the short term. If the loan rate adjusts in five years, your rents will be higher by then, which should cover it.
In other words, don’t judge the investment solely by its performance in year one.
#4 - Your real estate investment is less risky than the stock market or cryptocurrency
Investments like the stock market and cryptocurrency can be incredibly volatile, especially during periods of high inflation. Sudden changes in the economy can impact entire sectors or companies, causing their stocks to fall dramatically and quickly. Cryptocurrency rises and falls even more sporadically, often with no obvious cause. If there is an unexpected drop, your money could be lost instantly.
While it’s possible to make a lot of money in the stock market and in crypto over a short period of time, the risk of losing that money is also great. Investing in real estate doesn’t typically offer the instant gratification of these types of investments, but there’s also not nearly as much risk involved. You won’t go bankrupt overnight after buying a single family home or duplex, but with the stock market and crypto you just might.
Many of us have been conditioned to believe that cash flow is the most important part of investing in real estate, but this isn’t necessarily true. In today’s market, finding investment properties that generate high amounts of monthly cash flow isn’t as easy as it used to be. Luckily, cash flow isn’t everything.
When investing in real estate, your biggest money maker is going to be appreciation over the long term. What’s exciting is that your renter will pay off your mortgage while you wait for your property to rise in value, so your only real risk is your initial $60,000 down payment. As long as you invest in the right market at the right time, you’ll make that money back two-fold over a ten year period. If you invest that same $60,000 in the stock market or cryptocurrency it may also double or even triple over a decade, BUT you can also lose it all in just a day. This doesn’t happen with real estate, which is why so many believe it’s the best investment.
Looking to buy real estate with a strong appreciation potential?
Become a member of RealWealth to view sample property pro formas and to be connected with property teams around the country.