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SHOW NOTES FOR EPISODE 512: WHY CASH FLOW IS KING
When you buy rental properties based on cash flow, it’s the best strategy to achieve financial independence and to build a legacy to hand down to your family. But why? In today’s podcast, Bill explains how cash flow helps you achieve financial independence and seven reasons why cash flow is king!
Tip of the Week – Buy property with growth in mind.
When you invest in real estate, you may eventually want to sell it. Whether you intend to flip it immediately or hold on to it for a while, you’ll want to profit. The goal is to sell your property for more than you paid for it. Build your property value by making simple upgrades or additions. When you increase property value, you can sell it for more, and your hard work will pay off in a big way.
Why Cash Flow is King
If you’ve been listening to the Old Dawg’s REI Network Podcast for any amount of time you know that we always end every podcast with this statement: REMEMBER: CASH FLOW IS KING AND REAL ESTATE INVESTING THE MEANS!
And the reason we do that is because we believe that cash flow is the single most important factor when investing in real estate. Because, it’s the ability to generate passive cash flow income that will bring you to total financial independence!
What is passive cash flow income? It is a system/process/structure that will generate income for you without you having to do anything.
Well, let me just take a moment to qualify that statement:
You cannot generate 100% passive cash flow income without doing anything! That’s impossible! But, you can definitely do some key things upfront that can help you generate mostly passive cash flow that would require very little of your time and effort to maintain for the long term.
But before the passive aspect, let’s take a look at the not-so-passive aspects of generating cash flow!
You need to:
- Educate yourself on where and what kind of properties to buy and how to purchase such properties
- Put together a team (real estate agent, broker, wholesaler, attorney. accountant, banker, contractor, property manager)
- Put together a strategic plan
- Research your markets
- Find and analyze properties
- Purchase a property (either all in cash or through a mortgage)
- Set-up a reserves bank account
- Establish an asset protection strategy
- Buy insurance
- Make the property rentable
- Find a renter or tenant
- Maintain the property
- Try to retain the tenant
- Pay taxes and insurance
- Pay a monthly mortgage (unless you pay cash for the property)
- Make repairs, as needed, to keep tenants happy
- Manage the investment and the money that the property generates
- Establish systems to perpetuate and grow your investments
OK, so you’re probably thinking, that certainly doesn’t sound very passive to me!
Well, it isn’t… BUT the goal is this… if you do the right work upfront, you can skate later on!
For example, once you go through all the research, planning, evaluating and finally purchase a property, you can then hand the management of the property over to a good property manager (referred here to as PM). Now, of course, you don’t just hand the property over and that’s it. To do it right, you’ll need to
- Carefully research and interview many prospects before you can find a good PM
- Next, you’ll need to build in checks and balances to insure your PM is doing their job properly
- For example:
- Establish weekly and or monthly reports that show where your property is at, highlighting key financial and/or operational issues
- Meet with your PM regularly via phone, zoom or in person
- And then, you’ll need to regularly assess and evaluate your PM’s performance and, if necessary, implement changes to improve operations
- Once your PM is operating efficiently and according to your guidelines, you’re ready for the next step…
- Figuring out what to do with the cash flow income you are now receiving…
- For example:
Now, if you do this part right, you will still have things to do but not as often:
- You can meet with your PM, once a week, for 1 hour
- On once a month for one or two hours
- You may want to fly to the property (unannounced) once or twice a year
But, overall, once all your systems are in place there will be very little required for you to do for that property. It’s not completely passive but it’s very close.
Then, with the rest of your time, you could can go back to the 18 item check list I mentioned earlier to acquire another property, and repeat and repeat until you add enough properties to your portfolio to generate the monthly income you require for financial freedom.
Once you’ve reached your monthly income goal, you can stop buying properties and move to the “overseer” roll where you regularly meet with your PM or multiple PMs to stay on-top of your investments… It won’t be completely passive but maybe, if you manage it properly, you will only be spending 1 to 4 hours a week, to maintain your income. Pretty sweet, huh!
So, if you’re now probably saying, “Oh OK, it sounds better. But still a bit too good to be true” OK. So let’s dig a little deeper.
What is Cash Flow?
According to Investopedia Definition
Cash flow refers to the movements of money into and out of a business, typically categorized as cash flows from operations, investing, and financing.
There are different types of Cash Flow in business
- Operating cash flow includes all cash generated by a company’s main business activities.
- Investing cash flow includes all purchases of capital assets and investments in other business ventures.
- Financing cash flow includes all proceeds gained from issuing debt and equity as well as payments made by the company.
- Free cash flow, a measure commonly used by analysts to assess a company’s profitability, represents the cash a company generates after costs.
Real Estate Cash Flow is the amount of profit you bring in each month after collecting all income, paying all operating expenses, and setting aside cash reserves for future repairs. For buy-and-hold real estate investors, cash flow is the primary lever used to increase passive income.
When looking at a real estate investment, there are two main components you need to fully understand and be able to forecast: income and expenses. Understanding the key financials of a property IS CRITICAL and allows you to understand exactly what your cash flow is.
Let’s start with a simple equation:
Cash flow = Gross Rental Income – all expenses and money set aside for cash reserves
Here’s an example of how to calculate the monthly cash flow from a property, let’s say, in Indianapolis.
Monthly rental income: $1,000
Monthly operating expenses:
- Mortgage: $346
- Property taxes: $216
- Insurance: $38
- Property management: $100 (That’s 10% of my rental income. Note that fees vary between property management companies)
- Vacancy reserves: $50 (5% of my rental income, adjustable depending on risk tolerance)
- Repair reserves: $100 (10% of my rental income, adjustable depending on risk tolerance)
- Capital expense reserves: $50 (5% of rental income for roof replacement, rehab/upgrades, HVAC, other high cost capital expenses)
Total monthly expenses: $858
Cash flow: $100 ($1,000 – $858)
If your goal is $10,000 in monthly income, how many houses would you have to own? 100 houses.
Now that might sound discouraging to some but I know plenty of people who have done it.
However, next week, I will show you not only how to boost (double or quadruple) your cash flow significantly (which will require way fewer houses) but will show how other strategies (like multifamily) can significantly shorten the time to your goal.
The key here is not just generating cash flow – it’s building financial independence
Cash flow is important for a number of reasons. Here are seven reasons why cash flow is extremely important for you and your retirement.
1. So Your Investments Don’t Trap Your Life
You may be wondering how an investment could keep you trapped. The fact is that some people invest in stocks, bonds, mutual funds and other investments they can’t control. A major shift in the market could be devastating to a retiree who counts on those investments for survival.
Bad investments can trap you. But if you have rental property investments that are generating cash flow, you have a tangible asset that you can touch, feel and see that has REAL VALUE and it is something that people will always need – a place to live and a roof over their head. You’re not going to feel trapped, nor live in fear that the market may crash because your investment is solid and secure. Yes, all investments have a degree of risk but real estate is far more dependable than a piece of paper that says you own something you can see, touch or control. And that investment funds your financial freedom.
2. So You Can Afford To Invest
Not all of us earn a great deal of money. We’re all paying for our life expenses like food and rent. Some of us may even have to pay for our children’s schooling. All of these costs are necessities but they can certainly add up and become expensive.
Therefore, investing in a property that generates cash flow means that you can actually afford to invest when and where you want.
3. You Need Cash Flow to Grow Your Portfolio
Your cash flow can help you to expand your portfolio while your tenants pay down your mortgage. If you have cash flow behind you or if you have properties that are generating cash flow, you can use that cash flow to buy more properties. Many investors, who are still employed, use the cash flow from their properties to accelerate their mortgage pay off so that, by the time they retire, they may have the mortgage paid off in full to receive maximum cash flow.
4. Cash Flow Is Important For Contingency Purposes
If you have cash flow coming in on a regular basis, you can put some aside and save a fund that can be used in contingency situations. If one of your properties needs a hot water heater to be replaced, which can be expensive, you can afford to make that purchase.
By having cash flow coming in on a regular basis and a contingency fund saved, you’re more likely to be able to pay for those expenses that you didn’t expect.
5. You Can Start Seeing the Benefits Sooner
Not everyone wants to wait until they turn 65 before they see any benefits. If you are generating cash flow, you can start seeing the benefits sooner rather than later.
If you buy and manage your investments right, you will have passive income from your cash flow right now and use it for your lifestyle today.
6. So Someone Else Can Pay Off Your Mortgage For You
Rather than paying off your mortgage yourself, positive cash flow means that someone else is effectively paying off your mortgage for you.
The rental income is covering all of your expenses, including your interest repayments and then generating passive income on top of that. You can siphon that passive income back into your mortgage or you can even wait until the rental income goes up over time and switch from an interest only loan to a principal and interest loan and therefore pay off your property over time.
So having someone else pay off your mortgage for you is a pretty exciting idea and while it doesn’t happen right away, it is still exciting that someone else pays off your massive loan for you over time.
7. Cash Flow Helps You Achieve Financial Freedom
One of the things that I get really frustrated about is when people decide that they want to invest in rental properties but they don’t actually write a Strategic Plan. Without a plan, it’s difficult to achieve what you want.
Personally, I think financial freedom is a great goal to strive for! And it happens when you’ve got more passive income coming in then you’re spending in your everyday life. That means that you’re not reliant on a job, wage, pension or Social Security in order to live your life. You have the freedom to do what you want with your time, while your cash flowing properties produces passive income that could help you achieve financial freedom.
A lot of investors invest in a mix of properties having some that are negatively geared and some that are positively geared. They may even have all negatively geared properties. Then they accumulate a mass of properties and allow them to go up in value over time.
Eventually they sell off a couple of properties and use the equity they’ve gained to pay down the debt on the properties they kept and therefore turn them into a positive cash flow situation by the paying off the mortgage. This means that those properties then start to fund those people’s lifestyle and help them achieve financial freedom.
This concludes my seven reasons why cash flow is king! Hopefully I have convinced you that cash flow can be pretty cool and turned you into a lover of cash flow just like I am.
References:
https://www.investopedia.com/terms/c/cashflow.asp
https://onproperty.com.au/why-is-cash-flow-important/
https://learn.roofstock.com/blog/real-estate-cash-flow
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