So I’m talkin’ to what turns out to be a new client from a midwestern state, when he stops me dead in my tracks with the following statement. “I’ve been buyin’ small rental properties since the mid-’90′s and have built up my retirement income to over $1,500 a month.” I immediately realized we’d come to our initial tipping point. In the last 12-13 years he’d probably cost himself easily over a million bucks. That’s not something you glibly allow to roll off your tongue. I took a few seconds and asked him to keep an open mind. Whereupon he said something like, ‘uh oh’.
Bottom line, I gave him the verbal version of tonight’s post
This whole cash flow thing makes me nutso. You’d think there was an altar somewhere with the golden statue of the god of all that’s cash flow. I bet I’ve had this conversation more times than about just about anything else. Sometimes, I swear it’s like tellin’ an innocent kid there’s no Santa Claus — something I’d never do in a million years — just for the record. 
Between late night info-crappola, a seemingly infinite number of so-called eBooks on real estate investing, and various online ‘coaching’ sites, cash flow has been elevated to Holy Grail status. There’s just one itty bitty problem — investing for cash flow has sabotaged more retirements then you and I will ever really know.
‘Course the zillion dollar question is, why? Glad you asked. (Heads to closet for soapbox.)
Let’s create a real estate investor. 39 years old. Married with two kids. Wife works and makes $30,000 yearly. He’s a computer geek type and makes $70,000 a year. Solid credit. Own their own home. Save a grand a month. They have roughly $100,000 to invest. Their Sominex Account (cash reserves) amount to about $30,000 or so. Their cars are almost paid off. They pay their plastic each month as it comes in.
Take a minute to fully understand their position. They don’t have a lotta debt, except for the house, and a little on their cars. They’re pretty good savers too. What does that tell ya? It screams to me that they’ve been able to raise kids, live life, pay bills, and all without livin’ on next month’s paycheck. At 39 his income is far more likely than not to increase over the long haul. The same is probably true for his wife.
So we ask ourselves the question of the day.
When retirement is 26 years away, and they’re already living the way they want, and still saving money, why should cash flow from real estate investments be the primary target?
The answer? It shouldn’t be — period. End of sentence. Don’t pass Go, and don’t collect yer $200. In fact, if ya keep on insisting your investment goal is cash flow from Day 1, there’s a nasty irreversible surprise waitin’ for ya at the beginning of your retirement. Ironically, that surprise may be so nasty as to compel the postponement of your retirement altogether. Thinkin’ I’m being overly dramatic? Not in the least. I say that with complete confidence, as the cash flow approach is second only to Grandpa Economics in it’s sometimes cruel results.
Let’s first define what cash flow really is. First of all, here’s what it’s not — rocket science. Boiled down to its essence, cash flow is a yield earned on a basket of capital. It can be generated from real estate, EIULs (Do a search on this blog for EIUL), debt instruments, you name it. But the main principle is that the more capital you have in your basket at retirement, the bigger the income in terms of dead presidents.
See, not a single E=MC² in sight.
Now let’s take our investor’s original capital and see what 26 years might reap.
Even if I ignore my years of experience, and the cycles that come and go, his basket of after tax capital should end up somewhere between $1.5-2 Million. That assumes in a quarter century there will be no huge run-ups in value — not friggin’ likely. Let’s take the lowest figure and say he’ll be able to generate a 7% yield. That’s about $105,000 a year in retirement income. That doesn’t include EIUL income, all of which will be tax free. Or Social Security income. (Stop snickering.) Or the income from his ‘qualified retirement plan’ at work. (Again, stop snickering.)
It’s taken him over 12 years of real estate investing to acquire less than $20,000 in annual cash flow. Yet in just over twice that time, he could’ve benefited from over quintuple that amount. This simply isn’t a fair fight. In fact, it’s a joke. A bad joke, ‘cuz if he continues down the road he’s been on since ’95 he may find himself workin’ ’till he croaks. (Technical RE investment term.)
Oh, and did I mention the tiny factoid related to his after tax retirement income? By the time he’s followed Gramp’s advice to always opt for the cash flow, he’s found himself 65 years old with less income than he really needs, and it’s without any tax shelter whatsoever. Put more plainly, tax-wise he’s naked as a jay bird. By the time that realization sinks in, it’s way too late to do zip about it. Talk about purposefully puttin’ yourself between a rock and a hard place?
That place is harder than woodpecker lips. Only diamonds are harder ‘n that.
On the other hand, through a prudently executed Purposeful Plan, he’ll have not only reached retirement with 4-8 times the income, but that income will be 80-150% sheltered for Heaven’s sake.
Can I hear an Amen!!! from the congregation?
BawldGuy Takeaway: This isn’t to portray cash flow as bad, but to point out how when constructing a reasonable Purposeful Plan for your retirement, it’s all about the timing of the cash flow. If yer already savin’ money, and yer only gonna make more as time goes by, why in the name of Auntie Evie are ya investing for more? Isn’t retirement cash flow the idea here? Exactly.
BawldGuy Axiom: To the extent a real estate investor’s primary goal is cash flow, capital growth suffers. The reverse is equally true. A strategy of capital growth will strongly inhibit the generation of cash flow. This is from rules handed down from The Physics of Economics — and they will not be mocked.
Put another way, cash flow and capital growth are like fire and water — they tend to eliminate each other to the extent the other is present.
Though cash flow is sexy, it’s paradoxically true that the pursuit of capital growth is what in reality ensures maximum cash flow when you actually need it — at retirement.
Now putting soapbox back in the closet.
Here’s another reality. If you don’t instigate a conversation with me, we can’t figure your situation out together. So contact me some time around 4:30 yesterday afternoon, and let’s get this ball rollin’, OK?
Have a good one.
Related posts:
- Understanding What’s Important — It’s Usually Not a Bunch of Cash Flow
- How To Use Cash Flow To Sabotage Your Retirement — OR — The Faster He Peddles The Behinder He gets
- As A Real Estate Investor Ya Gotta Pick — Capital Growth or Cash Flow
- Cash Flow Makin’ a Chump Outa You? Trading Tomorrow’s $20 For Today’s Chump Change? Stop It!
- Picking Up Pennies — Needless Cash Flow — And Million Dollar Pizza & Beer
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‘Bottom line, I gave him the verbal version of tonight’s post’….After reading that line on top I got excited and settled into my chair really hoping to learn something. I don’t feel like you went in depth enough with the example. It would be sweet how your ‘cash-flow investor’ would fair against somebody doing it the way your advocate. I know everybody’s situation is different, but it’d really help to see an example of what you were talking about.
Hey Justin — I thought showing 13 years of investing resulting in less than $20,000 a year in annual cash flow vs 5 times that amount in only twice the time period would’ve been enough.
My way vs his way was clearly shown. If he’d of kept using his approach he’d of ended up with at best, giving the benefit of the doubt, $60-70,000 a year. Again, with a disastrous after tax bottom line.
I think I’m missing something here.
Just re-read the post…it really is good stuff.
So, what exactly should have the cash-flow investor done different? Use more leverage? Which in-turn will decrease cash-flow, but would net more captial growth and increased depreciable basis?
Justin — You’re on the right road now.
Here’s what happens.
When you invest early on for CF it’s based upon significantly less capital. This results in significantly less CF. Makes sense, right? But, if instead, you consistently increase your capital amount, you’re ensuring a larger yield on that capital upon retirement.
It boils down to this: The CF ‘worshiper’ ends up with far less capital from which he can derive a yield. The capital growth guy ends up having enjoyed far less CF during his working years, but enters retirement with a vault full of capital.
The tax shelter to which you refer simply adds either to the after tax cash flow during hold periods, OR to the offsetting of capital gains upon disposition of those holdings during working years.
The cap growth approach also, if Planned correctly, allows the investor to arrive at retirement not only with impressive income, but tax shelter income to boot. It’s all good.
I’d be happy to talk with you if you have any questions. Don’t be a stranger, OK?
It all makes sense now. Thank you sir.
Good to hear. Have a great weekend.
Is cash-flowing your living expenses and SEP-IRA with apartment buildings a good strategy? When retirement comes, your cash flow from real estate will have been maxing out your SEP-IRA for a presumably long time . At that point, it hardly matters what you sell the buildings for… that’s just icing on the cake after x years of tax-deferred SEP-IRA sweetness.
On the other hand, you mention quite correctly that by tying up precious cash in real estate, you do suffer a scary opportunity cost. I’m very curious where you’d invest this money though. Stocks? Bonds? REITs? ETFs? Mutual Funds?
Hey Gabs — It’s too tempting to pass up the ‘opportunity cost’ comment. Scary? I’m pretty sure my intent was never to imply missing out on potential Wall Street investments as scary. Just sayin’.
WHEN are you cash flowing your living expenses? If it’s at retirement, good for you. If it’s not, then you’re gonna retard your retirement’s income big time.
Where would I invest your IRA money?
Into growth region real estate, and EIULs, at least at this point. At 30% down a 3% rise in value gets you give or take a double digit capital growth rate. That is WITHOUT the cash flow injected into the equation.
Have I misunderstood what you mean by ‘cash flowing your living expenses’?