Learn about the nuances of cash flow, and understand how vacancies, operating expenses, underperformance, high debt payments, unforeseen costs, and economic downturns can impact your investment. Challenge the myth of steady positive cash flow, and discover strategies to manage uneven expenses. Gain insights into assessing long-term property performance and maximizing potential gains. Navigate the twists and turns of real estate investment with confidence.
Welcome to the next lesson.
Negative cash flow.
It’s important before making any investment to not only understand how the investment works and operates but also what your downside risk is. They say that the best investors are concerned with the upside, but more focused on protecting the downside. I would argue that the same absolutely applies to real estate investing. Once you’ve got a solid defense in place, you’re ready to go swing for the fences with your offense because you know, you’re protected.
The first type of risk that I want to talk about is negative cash flow. Don’t worry if you’ve never heard the term or concept of cash flow. It’s totally foreign to you. We’re going to get into the details of what exactly it is in later lessons but just know for now that cash flow is the money in your pocket at the end of each month and each year that you make from your rentals after paying all of your expenses. So at a very high level, you bring in money from rent, you pay all your expenses and your mortgage if you have one with that rent money, and if there’s anything left over, that’s your cash flow. And in an ideal situation, the cash flow is positive, meaning that you’re putting money into your pocket each and every month.
But what often happens is some months are positive. And then maybe you have a big expense or a pair one month, so the cash flow is negative. But then the following month it turns positive again. Because real estate expenses can be lumpy or they can occur at random intervals, we often smooth out all of our expenses equally over the 12 months in a year to make the math a little bit easier.
So what matters more than looking at a monthly snapshot is looking at the annual picture. Did you end the year on a per-property basis with more money than you started the year or less? And so when I say lumpy or random intervals when referring to expenses, think about your property taxes. In California, those are due twice a year. And so we have two months that have really high expenses because we’re paying our property taxes. The same thing can be said for insurance. If you pay your premium on an annual basis, you pay it once a year, you’re going to have a really big expense in one month versus you can spread it out equally sometimes over 12 months or quarterly, depending on your carrier. And so if a plumber has to come out to fix a leak one month, you’re going to have a big expense. And then the next month you might not have any kind of repairs. And so if we think about our expenses in terms of a graph, it probably looks like a sine wave or a heartbeat where it’s kind of staying flat and then going up and then staying flat and then going up. And so we want to make it easier on ourselves from a prediction standpoint. And so we usually spread these expenses out equally over the full year period.
So the thing to remember about real estate is that it’s often a slow and steady business. We might not be able to tell how the property actually performed until the end of the year, but we should be getting signals along the way.
So a property that loses money for one year over the course of owning the property for many years is really not a big deal, but a property that continually loses money when you purchase it with the thought and hope of it making money every year could be a problem. So it’s important to understand that properties do have the ability to require additional money each and every month to continue owning them, which is why the skills you learn in this academy are so critical because you’ll learn how to protect your downside.
And so what I want everyone to come away with is, if you own rental property, there absolutely is the possibility that you have to put more money into it on a monthly basis. And so people getting into real estate often hear, Oh, you can make so much money. Cash flow is great. It’s so easy. But again, until you understand the investment and how it actually works, and what the downsides are, I would recommend everybody take it slow, get educated, which is what you’re all doing here.
So I’ll see y’all in the next lesson.
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