This is the third installment of our series on the three types of Positive Cashflow Real Estate:

1. Tax Cashflow

2. Fake Cashflow

3. Real Cashflow

Last week we discussed the first of these (Tax Cashflow), cleverly designed to make Negatively Geared real-estate look like a good deal. As I said:

By allowing you to pay less personal income tax, the promoters of these schemes will show you that the property can pay it’s own way (Neutrally Cashflow or Neutrally Gear) or even Positive Cashflow!

Unfortunately, it’s all on paper … and, it relies on you earning a high income … and, will probably only work for one or two properties because you won’t have enough personal tax to ‘save’ for more properties than that.

Today, I will introduce you to a simple, but powerful concept that will allow you to take any piece of real-estate and create positive cashflow … it’s so simple, you’ll wonder why you didn’t think of it sooner 🙂 But, you’ll quickly see why I call it …

Fake Cashflow

If you want a property to produce positive cashflow without doing a lot of work and research, use the 7million7years Patented Positive Cashflow Formula:

Pay Cash!

Now, this isn’t a stupid idea, it’s actually a valuable – and, under-appreciated [AJC: pun intended] – Making Money 301 wealth-preservation strategy … and, it works because it eliminates a (actually, usually THE) major expense on your investment property: mortgage interest.

Without interest, the chances are that your property will produce enough rental income to cover vacancies, repairs & maintenance and other typical costs, yet still produce a very healthy profit … perhaps even a livable income for a MM301 ‘retiree’.

The problem, of course, is that the rest of us – those still trying to accumulate wealth – (a) don’t have enough cash to buy much (any?) real-estate outright, and (b) real-estate’s growth is typically just around inflation-to-6.5% (depending upon who you believe) … hardly earth-shattering.

But, we don’t HAVE to pay cash for a property to produce this kind of positive cashflow return, we just have to decide how much cash to put in … as best explained by Shafer Fincancial in a comment to a recent post:

Here is how it works. Most folks, including myself, advise re investors to make their properties cash flow for safety (comparing your costs with the rents received). So if one person can get a loan for 7% and the other can only get a loan for 9% in order to make it cash flow, the later will have to put down more capital (down payment). If you are leveraged at 80% LTV and a property cash flows you only have to tie up that 20% capital. However, if you are having to put down 25% to make the property cash flow because of a high interest rate on the loan then you have 5% more capital tied up in the property for the same capital appreciation.

$100,000 property
Person A cash flows with $20,000 down payment
Person B cash flows with a $25,000 down payment

Think about it:

You put 0% down and you have a negatively-geared ‘dog’ … and, if enough people do it, a future real-estate crash (a.k.a. ‘credit crunch’)  on your hands.

You put 100% down and you have a positively-geared ‘retirement investment’ that ‘only’ grows with inflation (unlike CD’s – which ONLY provide some income).

… surely, there is a ‘break-even’ point somewhere between the two, where the property will cashflow positive, but you only have to put in a deposit and you can borrow the rest from a bank like a ‘normal person’?

Yes there is, and we ‘twist’ the Shafer Financial example (he was talking about the ‘cost’ of different interest rates) to illustrate the point very nicely: Property B may be a ‘dog’ with a 20% down payment @ 9% interest, but if you just up it to a 25% down payment also at 9% interest, you lower your monthly mortgage payment just enough to make it break-even on a monthly (or yearly) basis, or even cashflow positive.

So, fiddle the numbers on a spreadsheet (with the help of your accountant, if necessary – they LOVE this kind of stuff!) and you will find the break-even point (i.e. the point where the property JUST starts to cashflow positive) and if you can afford the deposit, perhaps you have a ‘winner’?! 😉

But, it comes at a ‘cost’ or two:

1. You need to come up with a bigger deposit … which, means that you may not be able to buy as big/many properties as you like, and

2. The more money you put in, the lower your overall return (annual compound growth rate); again, Shafer Financial explains nicely:

The interest rate on mortgage debt on investment property does curtail capital appreciation …

$100,000 property
Person A cash flows with $20,000 down payment
Person B cash flows with a $25,000 down payment

Property appreciates 3% for five years. Aproximiate value of $116K.
For simplicity stake; No excess cash flow for five years (unlikely)
No tax advantages.

Person A ROI= 12.47%
Person B ROI= 10.4%

Having to put that extra $5K down to make the property cash flow cost you 2% in the return department. Note that the property only appreciated 3% per year, yet the rates of return were 10% and 12%!

Now in the real world you must account for the cash flow over time and the tax advantages to compute ROI. But this is a perfect example of how interest rates effect return. Also, note that the higher the leverage (above 75% LTV for most folks) the higher the interest rate is likely to go. So, there is usually a break even point for leverage/cash flow that takes into consideration the interest rate.

This is that ‘leverage’ thing that makes real-estate such a wonderful investment, producing returns (for well-selected / purchased real-estate) well above the naysayers moans that real-estate only grows “according to inflation” or “6.5% a year” (depending upon who you believe).

So, the problem with Fake Cashflow is that – while we can ‘force’ a Positive Cashflow out of almost any piece of real-estate by simply putting more of our own cash in it up front – it tends to reduce leverage, hence reduce our overall returns. This is why I call it ‘Fake Cashflow’ …

There has to be a solution … and there is: see you in the final installment in this series, where I show you how to find ‘Real Cashflow’ 🙂

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