How to Avoid Buying High Cash Flow Properties That Never Get Liftoff
I find myself in the midst of hundreds of conversations on High Cash Flow properties. We live in a time where cash flows have been very prosperous over the past couple of years and everybody wants in on the action. (Present company included!) Where I get concerned is when I talk with people who just bought property and they believe they are getting returns in the 20 and 30 percent category. These people are so terribly excited, they want to buy up everything they can get their hands on. Who wouldn’t do everything they can do to come up with down payment money to buy more of these?
Stop the madness, History tends to repeat itself
This is the point in the conversation that I get that cautionary feeling going through me. Seeing hundreds of over-eager investors lose everything during the recession resonates with me when I see these high returns lure new investors to the purchase.
Garbage in equals garbage out
Are returns truly what the pro-forma says it will be? Never take any seller’s words for it.
I see people spend more time planning a vacation than they do evaluating something as important as investment property. We always see sellers providing pro-forma’s showing how much money these investment properties can make.
Keep in mind they are motivated to sell and they know you want big returns so they make it look like a great return. Remember "garbage in" equals "garbage out". More times than not many expenses are conveniently left out to bring the positive cash flow higher. Then after you make the purchase you find these missed expenses appear in your inbox and voila, your cash flow is reduced.
Another way investors are tricked into thinking they have high cash flow is that the property actually does generate high cash flow (TODAY!) Then tomorrow repair requests start to appear on a regular basis. I have seen entire years, and as much as 2 or 3 YEARS, of positive cash flow get absorbed in repair items that have been deferred. This can often be discovered by doing a good and thorough inspection to uncover these deferred expenses that the seller has not addressed.
Any seasoned investor can tell you that your largest expense is tenant turnover. When buying investment properties in undesired areas or high crime areas the cash flows are often higher. The monthly numbers look good because the prices are cheap compared to rental rates. The problem is people move out of these properties as quickly as they move into them. The times that these properties are vacant between tenants you have zero cash flow. Additionally, you often have clean up and repair expenses to prep the property for rent again. Not to mention new leasing fees or expenses.
Indeed there are many ways to buy properties that look to be great investments on paper that never quite turn out that way. The cash flow just always seems to be deferred another month, and then another, and yet another.
How to evaluate an investment so you have quick and sustainable cash flow starting day one
The key aspect that makes great investors successful is the duplicable process of evaluating the investment property. Understanding how to look at the pro-forma report is paramount. If you want a better understanding of how to do this, I have it all here, Pro formas – broken down, dissected and analyzed.