Assuming Break-Even Cash Flow

When I discuss in other articles some of the benefits of investing in real estate - like appreciation, depreciation, leverage and equity build-up - I often assume that you will have break-even cash flow. But is that realistic?

Well, yes and no.

First, let's define what determines cash flow for a property. Cash flow is the difference between income from the property - usually rent - and expenses on the property. Expenses usually include taxes, insurance, management, maintenance and any debt payments. While taxes, insurance, management and maintenance can vary a little, what is largely within your direct control is the amount of the debt payments. How so?

Well, you control how much cash you put towards the purchase and how much of the purchase price you finance. If you put more down, your payments will be less. If you finance a larger amount, your payments will be more and you are more likely to have negative cash flow. If you look at negative cash flow as a function of down payment, you could think of negative cash flow as a deferred down payment that you are making over time.

So, can you assume that you will have break-even cash flow? Most people would argue that unless you are putting a large amount down, you are likely to have negative cash flow on a property when you first buy it. I would tend to agree, but what happens over time as rents go up? Well, you have some expenses that rise too - like taxes, insurance, management and maintenance – but usually the largest of your expenses on your property is still your mortgage payment. If you have a fixed mortgage payment, you should see an increase in cash flow over time.

So, while you may have negative cash flow when you first purchase a property, you should see significant positive cash flow as rents tend to rise over time. That is why I feel very comfortable making an assumption that your property can have break-even cash flow over a 30 year period when looking at the other benefits of real estate investing. It is a way to simplify the discussion to see how one benefit looks.

Of course, if you want to see how all the variables interact, I strongly encourage you to try the investment simulator at LearnToBeRich.com. You can try various real estate investing strategies in a fun interactive game format to see exactly how income and expenses can change over time and how they affect your investments and net worth.

Until my next post,

James