Investors – Cashflow is not KING anymore!!

I know many investors like me don’t want to hear anyone saying, “Cashflow is not King anymore” because that’s the basis for the passive income building strategy and financial freedom for years. But I just read an article which is published by author Dave Myer from BiggerPockets. He supported his argument with really great statistic analysis and it make real sense for this market.

See snippet of the long article with major pointers below,

If you’re familiar with BiggerPockets, you’ve likely heard of the 1 percent rule, which states that in order for a deal to be considered, it must have an RTP above 1 percent. While I wish this rule was still relevant, I think it’s time to retire it. The 1 percent rule was invented in a housing market with very different dynamics than the one we’re seeing today, and it has lost much of its utility.

We need new benchmarks for measuring “good” cash flow in 2021, starting with level-setting where cash flow in the U.S. sits today. To do that, I simulated cash flow (using recent purchase and rent data, alongside tax, insurance, and repair estimates) for 556 of the biggest metros in the U.S.

What I found is that the average RTP in the U.S. is 0.51 percent—well below the 1 percent rule. Even worse, that corresponds to an average cash-on-cash-return (CoCR) of -7 percent. Of all these markets, only sixteen offer a median RTP above 1 percent, and only twenty-five offer a median CoCR above 5 percent.”

For this reason, I believe that investors in 2021 need to be comfortable exploring markets that do not meet the 1 percent rule. Instead, I would argue that any market with a median RTP above .65 percent and any individual deal with an RTP above .70 percent is worthy of consideration. Likewise, it would have been unwise to accept a deal with a CoCR of only 5 percent in 2013, but today that deal might be the best thing on the market.

Investing in Equity

Equity has been part of the Real estate investment play forever. In the ABCDE of Real Estate investing, A – Appreciation and E – Equity building are the pillars which makes an investment better above Cash flow.

But Investing for equity is not always seen as an attractive long-term investment because it is illiquid. You cannot easily pull equity out of a property and use it to support your lifestyle—or retirement. But investing for equity is an excellent way to boost the total return you generate on your money, and it’s easier to come by than cash flow in the current market. You can also turn equity into cash flow later.

Market appreciation is what most people think of when they hear the term “appreciation.” Many think you can just buy a property, and over time it magically increases in value. But that’s not always been the case. In many areas of the country, market appreciation has traditionally been inconsistent and difficult to predict. Instead, big cities like New York, Seattle, and Austin tend to appreciate while other markets keep pace with inflation but not much else.

That has changed. Between January 2020 and May 2021, the average home price has grown 9.8 percent in the United States according to Zillow data. In that time, only twenty-three of the 911 measured markets saw prices decrease.  Furthermore, a whopping 845 of the markets had appreciation that outpaced inflation. That’s a lot of market appreciation.

Again, we need to adjust our expectations. While we at BiggerPockets have been saying for years that you shouldn’t rely on market appreciation, right now market appreciation is the norm, and I believe it will continue to be the norm for at least the next year or so. The consensus among experts is that property prices nationally are likely to continue to grow at least 4 per a year through 2022, and likely much higher.

— See he talks about Market appreciation which depends on the market dynamics

While market appreciation is dependent on macro-economic trends, forced appreciation is more controllable by an investor.

The idea behind forced appreciation is simple. Buy a property that has potential for improvements, improve it, and increase the value of the property by more than the cost of improvements.

This is the idea behind house flipping and the BRRRR method. As an example, let’s say you buy a property for $100,000 and put in $50,000 of improvements, and then the house appraises for $175,000. You’ve now “forced” the property to appreciate by $75,000 far faster than market appreciation would have. (Note: You only would profit $25,000 in this scenario.)

Forced appreciation was a solid strategy when cash flow was great, and forced appreciation is a solid strategy now. Because each rehab job is unique, it’s difficult to measure how well forced appreciation is working nationally in any individual markets, but I don’t believe anything has fundamentally changed about forced appreciation in the past few years, except that the price of lumber and a few other building materials has jumped of late and squeezed profit margins. Nonetheless, forced appreciation remains a great strategy in my book.

— BRRRR Strategy has been game changer for years now and we help investors implement BRRR strategy successfully for the last few years.

To underscore the strong returns that can be produced by market appreciation and amortization alone, I created a fake deal.

Purchase price$250,000
Annual rent income$13,600
Rent-to-price ratio0.45%
Down payment20% ($50,000)
Closing costs$40,000
Interest rate4%

This is a straight-up bad cash flow deal. In fact, for year one, I lost a whopping $6. So, you might be thinking I would get killed on this deal, but that’s not the case.

With modest increases in expenses, rent, and property value (3 percent each annually), this deal produced an average annualized ROI (AAROI) of more than 20 percent for the first five years, and a compound annual growth rate of 8.9 percent.

There are few obvious investing options right now, and we need to adjust our expectations to the current macroeconomic climate. Cash flow in real estate is hard to find. Bonds are unlikely to keep up with inflation. Stock valuations are sky high. But investing for equity in real estate is still a great option.

It’s not the sexiest choice in the world, but it is relatively low-risk, will almost certainly outpace inflation, and offers huge upsides if market appreciation continues even at half its current pace. In today’s day and age, a CAGR of 9.2 percent would exceed my expectations for return from any other asset class—stocks, bonds, gold, whatever.

I know it seems that investing for equity is counterintuitive to the passive income strategy that attracts many to real estate investing, but it’s not. It just turns it into a two-step process: build equity, then reallocate capital.

If you build up $1 million in equity over the next ten years (step one), you can liquidate your portfolio and then buy properties for cash to generate more cash flow. When buying properties for cash, cap rate equals CoCR, so if you buy a property for all cash at a 7 percent cap rate, that $1 million in equity can be turned into $70,000 in cash flow ($1M x .07). Pretty good! If you build up $2 million in equity, that’s $140,000 in cash flow, and so on.

I like to underscore this topic strongly and ask my investors to think about this new trend in building Equity instead of concentrating on Cashflow alone in this market condition.

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