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Cash flow may not save you!

N

nepoez

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I was just relaxing before going to bed and was thinking about why cash flow is so important but a thought sprung out. Imagine the following scenario:

You buy a property that`s cash flowing $200/m today. You feel pretty good about it. You were told that when the market goes downwards the cash flow will give you the ability to hold without using your own money.

Here comes next year, the market continues to go down and now the same quality property you bought can be had for 20% less. You think, no biggie, I got a $200/m cash flow so I have it covered.

Johnny comes along and buys your neighbour`s house. He is able to rent it for $300 less than you because he can cash flow with lower rent due to the low purchase price and lower financing costs.

A renter comes along, which property will he choose? you are now forced to go into -$100/m cash flow.

Is this logical or am I dreaming?
 
It is logical if most of the landlords on the market bought their properties 20% lower than you. And also because of economic downturn there are more renters than homeowners which drove the rent prices down.
Now how likely is this scenario?

Just because there are better deals at this time it does not automatically mean that rents are going down everywhere. Hopefully that $200 buffer will be enough to get you safe through the storm. In some situations it may not be.
 
If the overall rental market drops there is not much you can do but the likelihood that your new neiborough is going to charge below market because he can afford to is extremely unlikely. As a new landlord he will research the market, otherwise how will he know what to charge, and then charge accordingly.
In the event he does charge below market once he rents it out and it is off the market you ignore it.
 
Thanks for the analysis!

QUOTE (invst4profit @ Nov 25 2008, 06:19 AM) If the overall rental market drops there is not much you can do but the likelihood that your new neiborough is going to charge below market because he can afford to is extremely unlikely. As a new landlord he will research the market, otherwise how will he know what to charge, and then charge accordingly.
In the event he does charge below market once he rents it out and it is off the market you ignore it.
 
Hi Lucius,
Remember that you also have an advantage over people who bought in 2007 and paid top dollar. They need maximum possible rent or they`re in negative cash flow. You`ve bought at a discount to the peak so you`re in better shape. Of course people who bought in 2005, 2004, 2003 etc are potentially in the best shape because they need even less rent to break even. But just because you don`t need more rental income to stay afloat doesn`t mean you don`t want to charge the maximum the market will bear.
 
Thanks. I`m glad my theory is at odds to reality!

QUOTE (mortgageman @ Nov 25 2008, 08:23 AM) Hi Lucius,
Remember that you also have an advantage over people who bought in 2007 and paid top dollar. They need maximum possible rent or they`re in negative cash flow. You`ve bought at a discount to the peak so you`re in better shape. Of course people who bought in 2005, 2004, 2003 etc are potentially in the best shape because they need even less rent to break even. But just because you don`t need more rental income to stay afloat doesn`t mean you don`t want to charge the maximum the market will bear.
 
QUOTE (nepoez @ Nov 25 2008, 11:07 AM) Thanks. I`m glad my theory is at odds to reality!

I`m not sure your theory is all that far off from reality. I believe that there is another thread going on about rental prices dropping. Now I don`t know if that`s just seasonal or because people have started losing their jobs, vacancy rates have risen.

It would make sense that all landlords will want to get maximum rent possible so they will not undercut each other unless they have to. The situation in which they would have to is if vacancy rates rise, people lose jobs and can`t afford to pay higher rent, jobs disappear and migratory workers move away.

I think you are being prudent by asking these questions. Always be conservative with your numbers when you are doing your analysis. I think recently there was a thread where Thomas was discussing rents in a certain area of Edmonton and many other members were saying his rents were too low, well I think Thomas knows a thing or two about weathering all market conditions. It`s great to get the maximum rent if you can, but getting a reasonable rent and a great long term tenant may work out to be the better deal in the end.

Now would be a good time to pull out all your REIN info on proactive landlording.

-Terri
 
A logical concern from an individual investor, however it really comes down to supply and demand of housing for the particular area in question.All things being equal, rents have a history of doing the opposite of what this thread is concerned about when house prices are falling. Rents historically rise while house prices fall (again, all things being equal). If the population is stable, and house prices are falling, people become fearful of buying in the face of the downturn and elect to rent while they wait and see what will happen. These would-be buyers put their plans to buy on hold and take a wait-&-see approach to buying while the prices of houses correct.

In doing so, you can see how they are also adding themselves to the growing pool of renters demanding properties to rent. This is because the HAVE to live somewhere.... They`ve contributed themselves to now being competitors with other renters for the limited supply of quality properties for rent (this demand causes rents to rise).

The real wild card is the availability of properties to rent. If an area has overbuilt and there is clearly massive supply, then nepoaz`s theory may hold true. If it is not overbuilt, and supply of properties to rent is stable, then renting demand for those rental properites rises. Meaning rents rise (especially if the population for that area is continually growing while rental stock of housing for that area is stable).

This is why you generally see rents and prices play an interesting game against themselves. When prices rise, rents will often decrease (the pool of renters are lured into buying decreasing renting demand) and rents rise while house prices fall (pool of renters increase as they become fearful of buying - or it makes more sense to rent as mortgage payments are too high because prices got so far ahead of themselves).
 
Very interesting theory. But I think this mainly makes sense when migration is not a factor.QUOTE (dwb @ Nov 25 2008, 12:22 PM) A logical concern from an individual investor, however it really comes down to supply and demand of housing for the particular area in question.

All things being equal, rents have a history of doing the opposite of what this thread is concerned about when house prices are falling. Rents historically rise while house prices fall (again, all things being equal). If the population is stable, and house prices are falling, people become fearful of buying in the face of the downturn and elect to rent while they wait and see what will happen. These would-be buyers put their plans to buy on hold and take a wait-&-see approach to buying while the prices of houses correct.

In doing so, you can see how they are also adding themselves to the growing pool of renters demanding properties to rent. This is because the HAVE to live somewhere.... They`ve contributed themselves to now being competitors with other renters for the limited supply of quality properties for rent (this demand causes rents to rise).

The real wild card is the availability of properties to rent. If an area has overbuilt and there is clearly massive supply, then nepoaz`s theory may hold true. If it is not overbuilt, and supply of properties to rent is stable, then renting demand for those rental properites rises. Meaning rents rise (especially if the population for that area is continually growing while rental stock of housing for that area is stable).

This is why you generally see rents and prices play an interesting game against themselves. When prices rise, rents will often decrease (the pool of renters are lured into buying decreasing renting demand) and rents rise while house prices fall (pool of renters increase as they become fearful of buying - or it makes more sense to rent as mortgage payments are too high because prices got so far ahead of themselves).
 
I see this happen more in newer areas/new condo buildings...as so many people buying properties at the same time and renting out at the same time. Then competition happens and we see rent price drops as people trying to rent out their units first. Where as in older areas, this doesn`t happen, in fact, I see rent increase as it`s much harder for people to buy house now.

I think being proactive is most important, have better marketing , advertising, and know your market!! Don`t sweet talk yourself that you can get highest rent possible. Be consertive before buying. And treat your existing good-tenants well so they don`t move out soon.

Also, if i am a buyer who just brought a property with 20% less...I will still want the "market price" for the rent to max my profit...

just my 2 cents.
 
That is a very important thought to follow. Remembering that as real estate investors we are actually `business owners` we need to focus on what risk factors come into play over the long term of your investment.

That is why the Goldmine Scorecard is so important when investing. It helps identify towns and cities that have lower risk compared to other regions in the target province or country.

Migration is truly one of the numbers for sure, so is NPR (Non-permanent resident growth), good solid tax systems designed to bring in jobs not chase them away as well as all of the other 12 factors.

Then, even in the case where rentals are tougher to rent, it is important to note that you can never use `vacancy rates` as an excuse. Those are average numbers meaning that some properties are vacant and some are full. Our job, as investors is to manage our business and market better than others. For instance, during times of ultra-high vacancy (25%+) in Grande Cache Alberta a few years ago, I know of people who`s building remained full of happily paying tenants because they did respond to the market, they became THE place to live (as there are always renters), because at even a 25% vacancy means that 75% of the suites are filled. Be pro-active and make them be YOURS!
 
QUOTE Is this logical or am I dreaming?

Totally logical! And a very good question to be asking.

Rents aren`t fixed, nor do they always go up. In an environment of hiring freezes, layoffs, flat wages, low consumer confidence, and overall illiquidity, it doesn`t take a genius to surmise that rents will probably either be flat, or drop.
 
QUOTE (Jack @ Nov 25 2008, 08:40 PM) Totally logical! And a very good question to be asking. Rents aren`t fixed, nor do they always go up. In an environment of hiring freezes, layoffs, flat wages, low consumer confidence, and overall illiquidity, it doesn`t take a genius to surmise that rents will probably either be flat, or drop.Where will these these people live?

I understand in these people in the above situations that you outline likely would put their intentions to purchase a home on hold. But in doing so, these same folks would be forced to join the growing pool of people with intentions to rent.

In other words, what happens when there is a growing pool of people/families no longer interested in purchasing a home? They then become interested in renting a home instead.

So if this pool of individuals are demanding to rent a fixed supply of houses, then demand outstrips supply and rent subsequently goes up.

The market (via supply/demand) determines the rent that landlords charge, not the other way around.

If there is a growing pool of renters competing against one another for a fixed supply of houses, it doesn`t take a genius to surmise that rents go up. If the town is not in a quality goldmine scorecard town and that town is not economically diversified then all bets are off as yes, it can become prey to the work environment you mention (ie a small forestry dependent town announcing forestry related layoffs in BC with forestry dominating that town`s industry) .
 
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