Buy For Cash Flow But Plan For Debt

This is part two to this post we shared last week about one of the more emotional experiences we've had as a family investing in real estate.

This week, we'll share some of the real estate rules we now live by and some of the not-so-obvious observations about ourselves that we've made.

But first, let's share how that particular story ends.

We held onto that "quick flip" for ten years and then finally sold it.

After ten years we sold it and broke even.

That's right, it took ten years for the property to regain its value and when we sold it we were able to recoup our losses.

However, that doesn't take into account the opportunity cost of the money that we were using to plug the monthly losses for ten years.

And, as mentioned earlier, the emotional scars from that experience will never go away.

Do you know what it's like worrying about losing money every month - for ten years?  Not fun.

But here's the interesting part.  It was during that experience that we made some critical observations.

We realized that there were smaller properties in Mississauga that had also lost a ton of value but because the debt (the mortgage) on them was much smaller those owners were able to rent out their properties and either break even or be very close to breaking even.

And because they had smaller properties they weren't stuck trying to find U.S. Executives in Canada looking to rent out 4,400 square foot McMansions with three car garages like we were.

So the owners of smaller properties had zero or much less monthly negative cash flow than we had and had more demand for their properties.  That meant that as tenants left their properties didn't sit vacant for nearly as long.

And then we noticed that if the owners of those smaller residential properties owned them in areas with growing population (e.g. Mississauga in the 1990s) with good income levels (Mississauga is a bedroom community to the job-rich Toronto) that made things even better because the demand and ability of tenants to pay rent was high.

That may seem embarrassing to admit but until then we hadn't realized this.

We didn't put much thought into the environment we were investing in.  We just focused on the specific street or subdivision we were buying into.

We forgot about the big picture.

And we thought investing meant "flipping" properties.  We now call what we did "speculation".  Hoping for a "greater fool" that would pay more than we did for the property.

To us today, investing is about getting a return on your investment as fast as possible via cash flow.

There's no secret to that right?  There are books, seminars, courses, even board games about cash flow.

But during that time we also realized that the people who made the most money in real estate are the ones that manage debt the best.

Those people who managed debt the best were able to survive through tough markets.

See, we had a tough time managing the debt on that high-end property because the mortgage was expensive to carry every month.

During the early 1990s, if memory serves, interest rates went up 2.9% in one month.  Can you imagine that happening to all of the Canadians holding variable rate mortgages in today?

To make money in real estate you often have to survive through a few lean years.

So managing debt is of critical importance to your longevity.

We now don't solely analyze properties based on positive cash flow.

The old mantra, "cash flow is king" doesn't mean much to us.

It's important but it's not the whole story.

Whenever we look at a property we're always asking two things:

1. Will it cash flow?
2. If we have a vacancy a year from today how easily can we cover the debt payments?

Question number two forces us to purchase properties that are in demand most, in growing communities, with diverse employment and that are in good condition and on good streets etc.

Question number two also forces us to watch interest rates like a hawk.  And that forces us to learn about the bond market, the Bank of Canada and the U.S. Federal Reserve.

To summarize...

We buy for cash flow today but plan for debt payments tomorrow.

This is of constant concern to us.  And we've noticed it makes us better, smarter investors.

Here's what else we learned on that particular property.

The banks don't offer everyone the same mortgage products.  Depending on your relationship with the banks they may be more willing to lend to you than the next guy.

Magically a mortgage product may be available to you that isn't available to everyone else.  Or perhaps a mandatory debt ratio doesn't become so mandatory.

We also learned that the real estate agent community can serve you well.  Good relationships with Realtors give you access to buyers, investors, sellers and tenants.

And if you treat Realtors well when the going is good they'll remember you when you need to call in a few favours.

And if you've nurtured your relationships over the years people will bend over backwards to help you out.

It has always been our relationships with Bankers, Brokers, Lawyers and Accountants that have paid the biggest returns.

Whenever we ran into a problem during those tough years we had someone who knew more than us to go to.  And because they liked us so they never hesitated to help.

For that, we're forever grateful.

And that's what we want to impress upon you here.

It's not the property or the cash flow that will make you the most money.

It's the people you surround yourself with.  The experts you know and your relationship with them.

You've likely heard this from us before, the late Jim Rohn has this great quote,

We're always looking to establish new long-term relationships with good people.

Many people we know will never spend $250 to have a consultation with a good Lawyer or Adviser.

We will.

We actually cherish the opportunity.  We look at that $250 as an opportunity to begin a relationship.  It's an investment in our own future.

Even when times were tough and $250 was a very big deal we spent it.  It hurt, but we did it.

But you don't have to spend money to develop good relationships.  Mostly it's just about offering value to people and treating them with respect.

When we both moved into sales from technical support we both read a lot of cold calling books, negotiating books, closing strategies books ... you name it, we read it.

And when we got serious about real estate we read almost every single real estate book in print, Canadian and American.

But it was a book that had nothing to do with sales or real estate that has likely been responsible for more profit to us than anything else.

It was Dale Carnegie's, How To Win Friends & Influence People.  It's a classic and everything shared by Carnegie are things you can do for free every day.

If you're spending a lot of time learning about investing and real estate, don't forget to invest some time into building relationships and working with people.

Real estate is full of them ... from Lawyers to Tenants to Sellers ... there's a lot of people to deal with in this business.

Having the right person to call at the right time has been hugely valuable.

We'll leave you with this:

First, buy for cash flow but plan for debt.

Second, build a solid foundation of relationships around you.  Over the years they'll be more valuable to you than your properties ... for many reasons.

Your Life. Your Terms.