Today I’m addressing the investor interested in growing their net worth through real estate. I’m not talking about those who are investing solely for the benefit of monthly cash flow. Furthermore, there is much room for folks to disagree with what they think the #1 most abused principle might be. I think it’s this one. I’m sure it’s a frequent hot topic around the family fireplace in your home, right?.
Regardless of the passage of time, one of the constants remaining firmly implanted in many investors’ mindset is the idea that an investment property without abundant cash flow is to be avoided at all costs. The problem inherent with that school of thought is rooted in a few related principles, plus the difference between today’s realities and Grandpa’s memory of the way ‘it used to be’ — which in reality means to Grandpa, ‘the way it should be’.
The Principle in play: To the extent you go for growth you retard cash flow — and vice versa.
A very simple way of saying pick one. You want more cash flow in a particular region, you must begin with a larger equity
position. If you wish for your capital growth velocity to be greater, you must, to the extent prudent, increase leverage. Also, put enough oversized down payments into several properties, and before you know it, the guy who isn’t chasing chump change cash flow has bought a couple extra properties — using the same capital amount you did.
Notice how this isn’t rocket science. As a matter of fact, a principle of Purposeful Planning calls for the aggressive avoidance of growth inhibiting behaviors when capital growth is your investment goal.
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Please don’t allow me to give the wrong impression here. The ‘there must be cash flow school‘ is just as valid as any new approach or thinking. After all, who would argue against having cash flow, if that’s all you were talking about, right? An investor won’t go wrong limiting themselves to buying only cash flow properties.
They will however limit the size of their menu, as properties offering both leverage and cash flow, (regions for that matter) are few and far between. Consequently, those who insist on having their cake and eating too, will find themselves spending the majority of their time looking, instead of doing. That’s fine and dandy if you don’t have much capital. If you’re trying to spend a couple hundred grand using low downs while demanding cash flow — hunker down good buddy, cuz yer in fer a buncha lookin’.
Your also in for a less rewarding retirement.
This wasn’t as nearly universally true a short while back.
For example: Clients in San Diego were consistently using great leverage while enjoying a modest cash flow up until as late as 2002-03. Up to 2000 it was possible in most of the area. Now? In San Diego using leverage to a break-even is anything bought with less than a 30% down payment. This is why I’m telling SD income property owners to move their equities to lower priced growth regions. They’ll acquire more property with far superior leverage, while gaining more actual capital growth dollars — but with the exact same net equity. There’s simply no argument, objectively speaking, for staying in San Diego with our real estate investment capital.
Here’s the point.
There are enough growth regions around the country that allow for decent leverage. There are precious few that allow that leverage and reward you with cash flow. If you’re an investor wanting growth you’re not concerned with cash flow.
Let’s say you’re a married couple in your late 30′s to late 40′s, and earning a total of $75,000 yearly. Unless you’re living up to your eyeballs, (which means you haven’t managed to save any real money anyway) what do you care about cash flow? You need to grow your net worth as big and as quickly and as prudently (capital P) as you can. Don’t lose sight of your main goal and keep your eyes on the prize: Retirement income.
What is cash flow?
All cash flow, in the final analysis, is simply a yield on capital invested. If two investors put a million and two million bucks respectively into an investment upon retirement, yielding 8% — they both make 8%. The difference, of course, is the guy with twice as much capital is now sitting in retirement with twice as much monthly income. Duh. So by stressing over cash flow when your main goal is, or at least should be, growth, you’ve sacrificed future retirement income. You want to be the guy with the two mil, right? Right.
Ah, now I have your attention.
The lesson is to grow your net worth like crazy — then just before and in anticipation of retirement — convert your energy to obtaining cash flow — yeah, like crazy.
Let’s get this boiled down to where we all live — dollars in our Levis.
Over the long haul — I’ve seen investors literally cost themselves from $1-3,000,000 in net worth by making just this kind of mistake. It’s not that hard — when your mistake is compounded and repeated over a couple decades. Let’s take the midpoint — $1,500,000. At just a 6% yield — chasing cash flow to the extent you’ve consistently retarded your capital growth — your retirement income has been reduced — forever — by $90,000 a year. What?!! Yep — $90,000 every year. And you lost it because you were chasing chump change during the biggest earning years of your life.
Imagine the guy next door getting to live on almost a million bucks more over his first decade of retirement — just because he didn’t chase chump change cash flow while he was earning well over what he needed to live very comfortably.
The only benefit I’ve ever scene from a growth client chasing cash flow, is their ability to brag about it at their neighbor’s backyard BBQ.
They won’t be bragging when it comes to adding up their retirement cash flow — and isn’t retirement when they really
wanted needed it?
Yeah, I thought so too.