My strategy for investing in rental properties is based on cash flow, not my properties appreciating. Do I want them to appreciate? Yes! It allows me to refinance easier and possibly pull cash out to buy more properties if I need to. However, I do not need my rental properties to appreciate to make money and get good returns. I buy houses for cash flow and not appreciation. To calculate cash flow, check out our cash flow calculator.
I am making over 20% cash on cash return on my rentals. I detail exactly how I do this in my complete guide to purchasing long-term rental properties, which includes information on mortgages, buying properties, strategies and detailed numbers.
Hoping for appreciation on rental properties can get investors into trouble
One of the biggest mistakes I see investors make is buying rental properties with little or no cash flow in hopes the homes will appreciate in value. This is not investing in my mind, this is speculating that the market will increase in value. I never buy a property with my only profit potential being appreciation; I want cash flow. Here is a great article on how to increase cash flow on rental properties.
The first thing I do when I buy houses is buy below market value or improve/repair a property to add value. In addition to buying homes below market value, I always buy a property with positive cash flow. Positive cash flow allows me to bring in income as soon as I rent the home. Because I am investing for cash flow, I do not worry about home values. If home values go down, it doesn’t matter to me because I am making money from cash flow, and I don’t need to sell the home. In fact, I don’t want to sell because the property is making me money every month. I always invest for cash flow, not appreciation.
Rental properties are very expensive if you don’t have positive cash flow
The biggest problem with buying a rental property with negative cash flow is investors almost always underestimate their expenses. The fact they are buying a property with negative cash flow means they are usually stretching their buying criteria to make the deal. Repairs and expenses almost always exceed expectations, unless you assume there will be many unknown costs. It is always best to error on the side of caution when calculating expenses, especially if you are new to investing.
Many beginning investors do not account for the unknown because they really want to make a deal work. It is very easy to justify numbers that don’t make sense when you are a beginner investor looking for your first deal. I under estimated expenses all the time when I started investing in rental properties. I used minimum repair and expense numbers hoping that things would work out. When you underestimate expenses, you are letting emotions make the deal, which is a big mistake. If you really want to make a deal work, and you fudge the numbers to get everything to line up correctly, you may end up with negative cash flow every month.
Even if you plan for negative cash flow most investors cannot maintain it
Most investors who buy properties with negative cash flow get tired of writing checks very quickly. As I just discussed, most investors underestimate their expenses and with negative cash flow that can mean they are paying out hundreds of dollars each month on one property. While that investor is waiting for the home to appreciate in value, they are losing thousands a year in negative cash flow. The investor realizes very quickly that it does not make sense to hope the housing market will increase while they continue to lose money. The investors only choice is to continue to dump cash into the property every month or to sell at a loss. Even if the investor can sell the home for as much as they bought it for or slightly more, the cost of selling a home will eat up all the profit and then some. This happened to many investors when the Real Estate bubble burst a few years ago. Investors were investing based purely off anticipated appreciation without regards to cash flow or long-term scenarios. Right now many people feel we are in a similar bubble, although I am not so sure. If you buy houses for cash flow and not appreciation, a housing bubble will not be of great concern.
Cash flow is the key to making money with rental properties
The simple way to avoid shelling out cash every month on a rental, is to invest in a home that cash flows. If values go down, rents may go down as well, but unless your margins are really tight, you will still cash flow and you won’t have to sell. The easiest way to lose money in real estate is when you have to sell your property in a buyers market and you need to sell it quick. The only buyer may be an investor like myself looking for a great deal!
Predicting the real estate market does not work for me
Even though prices are going up now, no one can predict what they will do in the future. There are too many economic unknowns to know what the housing market will do. Interest rates could rise, the US economy could tank, the world economy could tank and destroy our housing market. Buy houses based on cash flow, and these factors may affect your bottom line, but they won’t bury you.
How to figure cash flow on rental properties
Many investors forget to include all the expenses that will be needed to make a profit on rental properties. To have positive cash flow you need to have rents exceed your mortgage payments by a large margin. You will have to pay your mortgage payment, taxes and insurance at a minimum every month. You will also have added expenses that could include HOA payments, utilities, maintenance and property management fees if you don’t manage the properties yourself. Here is a great tool to help you figure cash flow; cash flow calculator.
For more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook and is an Amazon best seller.