What is Cash Flow?
Cash Flow is the bread and butter of passive income! Cash Flow is easily described as the difference between your income, and your expenses.
For example, if you earn $1,000 in rental income and the total expenses for the property were $900 that month, your cash flow is $100!
Cash flow is a concept used in business, dividend stocks, and all sorts of passive income strategies. For this article we will be discussing the benefits of cash flow as it pertains to real estate investing!
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Why is Cash Flow Investing Safer?
This investing strategy is based on the income a property generates, and not the property value. When done correctly this can hedge against recessions!
For example, my duplex is currently rented for $1015 a month ($515/$500) and my principle, interest, Taxes, and Insurance (PITI) is $589/month. Of this additional $426 a month I budget $200 for reserve funds and the rest gets reinvested. I am not worried about whether the value of my property increases or decreases because I’m making the same amount until one of those tenants moves out.
If the market crashes, homeowners that are forced to foreclose will need to find a home to rent. For this reason, rent prices are usually pretty safe in a downward trending market. The law of supply and demand explains this because more renters, with the same amount of rental properties, = more valuable rental properties!
Also, as long as you keep renting you will never have to worry about the mortgage payment because your tenants are paying it!
Buy and Investment, Not a Home
When purchasing a home that will not be your “forever home” it is critical that you evaluate whether or not that rental income will be able to cover the properties’ expenses. Too many people buy a home, and the market depreciates, leaving them with a property that is bleeding cash, and they can’t even sell it!
More information about this here.
How Much Cash Flow Does A Good Investment Make?
That depends on your cash-on-cash return!
This is a common question, and there is no set answer. If your down payment is $6,000 and you earn $100/month ($1200/yr = 5 years to get your money back) that would be a great return! However, if your down payment is $150k (20% down on a $750k property in a market such as Hawaii) that same $100/month return would be absolutely TERRIBLE!
That is why using the cash-on-cash (COC) return metric is valuable! The formula for this is simply to divide your annual cash flow by the total amount of cash invested.
In our first example above $1200 / $6000 = 20% COC return
In our second example $1200 / $150k = 0.8% COC return (Ally Bank gives higher returns on their savings account!)
For this reason, I recommend using cash flow analysis to verify the property will be able to weather a recession. Then use the cash-on-cash return formula to decide if it is a good enough return for you!
Cash Flow Board Game
Robert Kiyosaki created The Cash Flow Board Game. Yes, the same Robert Kiyosaki that wrote Rich Dad Poor Dad!
This game is a fun way to learn about passive income, and how to exit the “rat-race” (working your entire life). I thoroughly enjoy playing this game, as it is both fun and educational. I have been to several meetups that were focused around this board game!
You can have a lot of fun playing with friends, or starting your own meetup with this game!
This method of investing is, in my opinion, the best way to purchase real estate. If the property is cash-flowing it is an asset!
If you invest for appreciation you may be losing money every month until you sell. Not to mention, if you’re losing money and the market crashes you could be screwed!
Don’t invest based on market speculation, invest based on cash flow and enjoy appreciation as a welcome bonus!