If you have ever watched the hit TV show Shark Tank (Dragons’ Den in Canada) you will surely know the words of one of the celebrity investors, the self proclaimed Mr. Wonderful, Mr. Kevin O’Leary ‘When do I get my money back if I invest in your business?’ The same question should be asked by an investor before they purchase a rental property or participate in a Joint Venture -or else why would one invest?
One of the best ways to recoup your investment is rent you receive from tenants. Cash Flow refers to the net income from rent after deducting all the expenses (mortgage , insurance , repairs, management fees , vacancy etc.). Cash flow may be positive (gross income is greater than expenses) or negative (gross income is less than expenses). Positive cash flow allows the investor to recoup the money invested for the purchase of the rental property. Negative cash flow means the investor is not only reducing the amount they recoup on the original investment, but the investor also needs to write a check each month to keep up with the properties’ expenses. The larger the cash flow and the smaller the expense, the greater the positive cash flow and the earlier the investor can recoup the original investment.
Cash Flow = Rent Income – Expenses
It takes careful analysis before one should decide to buy a rental property, thus ensuring positive cash flow from day one. Once you buy a positive cash flow property, you also need to implement a solid and trustworthy management team to handle the said property in order to control expenses and preserve the positive cash flow.
Cash Flow Versus Appreciation
Many investors buy negative cash flow properties in the hope that appreciation in the value of the property will be how they make their money. Appreciation is defined as the increase in value of a property over time due to various factors such as inflation, supply and demand, capital improvements, etc…. Real estate investors should always ensure the income property has positive cash flow and the potential for capital appreciation. An investor should have a good understanding of the factors that cause real estate to appreciate in value, many of which are hard to predict, somewhat like looking into a crystal ball.
I know of a Canadian investor who bought a condo in Toronto for $260,000 CDN. She has a mortgage of $ 1,100 per month and average monthly expenses of $500 but collects only $ 1,200 per month in rent. Rent $1200.00 – Expenses $1700.00 = $500.00 negative cash flow. The cost of owning the property does not make any financial sense, right? Every month this investor needs to pay $500 ($6,000 annually) of her own money just to keep up. This investor is surely banking on the condo appreciating in value like most Toronto investors, or for that matter investors in many large markets such as Los Angeles, New York City, San Francisco, Vancouver, London, and Tokyo.
Investing based on appreciation is not a sure thing. Real estate value can suddenly crash – this is what happened in 2008 – or can be flat or slowly rising for extended periods of time leaving investors with a negative investment.
One example of the type of cash flow rich investments we like, and regularly purchase, for our Joint Venture investors is a Buffalo 4 Plex (which we acquired for $106,000 US) that provides gross monthly rent of $1,850 ($22,200 annually). Even after subtracting all expenses of $1000 per month, we still have a net positive cash flow of $850 per month ($10,200 annually). This is all true of our property investments we acquire on behalf of our Joint Venture Partners. They are all cash flow positive, providing our investors with a superior investment, earning excellent returns, and not dependent upon property values increasing.