When you began researching Real Estate Investing, you probably heard lots of comments about “Gotta be Positive Cash Flow” and “If it isn’t Positive Cash Flow, it’s a terrible investment. Run Away”. I cringe everytime I hear an Experienced Investor telling a New Investor to keep saving their money until they find a Positive Cash Flow Property.
- If there was a Positive Cash Flow Property available in the price range of a New Investor (which is usually on the lower end of the market), a New Investor won’t even have a chance to buy it.
- Pre-existing Positive cash flow units are rarely sold. They make good and easy money. No one is selling them, unless they’ve had a major life disruption (death, divorce, etc). Sometimes a New Building is advertising Positive Cash Flow, but that is speculation. The Developer has no idea what the units will actually rent for, or when the building will actually be completed. They are guessing. And speculating in real estate is quite risky. Amazing returns (when it works out), but quite risky.
- Even if a PCF Property was for sale, an experienced Investor is going to have cash ready to make a quick and clean purchase. A New Investor isn’t ready to jump that quick.
- The really shady Experienced Investors will intentionally tell new Investors to “keep saving their money”. They don’t want more people competing for the same pool of properties that they want to buy. Should you save money? Yes. Should you save your money waiting for a PCF property? I personally say No. You might as well be waiting for a leprechaun, or for your lottery numbers to hit. That day ain’t coming.
Negative Cash Flow is your New Best Friend.
When we first expose people to this idea, it’s hard for them to wrap their heads around. We are saying the opposite of everything you’ve ever been told. So I ask you to trust me for just a few minutes.
Pick a property that you would love to own. An Investment Property.
If I said to you “Hey, I am going to give you $5000 a month, but you have to give me $1000”, you’d probably think that was a good deal (and that I was crazy, or laundering money). But that is exactly how Negative Cash Flow works. Sure, you might need to pay $1000 out of your own pocket each month to subsidize the property, but you are getting far more money back. There is more good news.
The Negative Cash Flow is usually only for the first few years. It’s not forever. In the first year of property ownership, the Mortgage Loan is the highest it will ever be. And that means the Mortgage Interest is the highest it will ever be. A Mortgage Payment has two parts — Mortgage Interest (an expense, paid to the Lender) and Mortgage Principal (an asset, payable to you … later. When you sell the property). To truly get this point across, you’d have to listen to me drone on about Amortization Tables and Principal Paydown. With each Mortgage Payment you make, some pays off the interest; some puts money into your Principal Piggy Bank. Although you won’t have access to your Principal Piggy Bank until you sell or refinance, it is still your money. When New Investors look at a property, they only look at the Cash Flow in the first year. Chances are good that it’s Negative Cash Flow for the first five years. Then the scales tip in Year 6. Now you are enjoying a property that you only paid a small amount for in the first 5 years.
Short Term Rental Rates rise faster than other property ownership expenses. It’s not uncommon for Short Term Rental Rates to rise 10% per year. So your Gross Income increase by 10%, but your expenses didn’t. Heat, Light, Power, Wages for Cleaning Staff — all of those expenses usually only raise by the cost of inflation. Sometimes they don’t rise at all from year to year. Sometimes things like Advertising or Televisions get cheaper. So that gap between Income and Expenses starts to get bigger. We’ve seen some years where the rise in rental rates has been 28% due to excessively high demand.
Real Estate appreciates over time. There have been times in history that Real Estate Prices have taken a massive nosedive (2008, we are looking at you!), so people get scared that it could happen again. Yeah. It could happen again. But it only matters if you *must* sell your property. If you don’t have to sell, you’re probably fine. People will always need a place to live. People will always like to take vacations. Assuming that you paid a reasonable price when you purchased your real estate (you didn’t overpay because someone hoodwinked you), you’ll be fine. So now we’ve got that Principal Paydown working like a forced Savings Account, and we’ve got the Property Appreciation working in our favour.
You like to vacation, right? Let’s hypothetically say that your Negative Cash Flow Lifestyle Property takes $1000 out of your pocket for the first few years. How much would you have paid to vacation with your family (if you had rented someone else’s property and put money in their pocket), while you instead stayed at your own property? Using your own Vacation Property will only cost you money in two ways:
- The Cleaning Cost. And the Cleaning Cost will be almost the same whether you stay one night, or 21 nights. So stay as long as you can … because your Lifestyle Property is probably in some gorgeous mountain, beach, or metropolitan area. Work Less. Travel More.
- The Lost Revenue. If this is primarily a Lifestyle Investment, don’t stay at your property in High Season and on holidays. … but you can stay all the time during times that it would have been vacant anyway. It doesn’t really cost you anything.
So the Negative Cash Flow wasn’t a terrible idea, was it? Even though most Experienced Investors will tell you otherwise. You have paid down your Mortgage Principal, you bought the house at yesterday’s price and it keeps going up in value, and you got to spend quality time on vacation. Hopefully making some memories with friends and family. And a few years in, the scales will tip into Positive Cash Flow.
Have I convinced you to stop being afraid of Negative Cash Flow yet?