When Money Flows Like Water

Water is always flowing.  And so is money.  Even if you have cash sitting in a box, your money is moving.

How can this be? 

Think of your business (which is your real estate) and all the ways that money moves in and out, much like a body of water.  The best type of investments are those that are like a reservoir with a steady water supply flowing in and filling up the reservoir.  The water comes in, is collected, and released slowly for expenses, or perhaps all at once upon sale of the property.  But even in this system there is a leak.  Just as few things are water tight, so even the best property is not perfectly cash flow efficient.  There is inflation, changes in property and income taxes, loss of tenants, and so on that create holes in your cash reservoir.   Same for that cash stashed in a box-inflation is like a slow leak on the value of your non-working cash.

This is why understanding and managing cash flow is of the utmost importance in personal and business finance.  Otherwise, your cash flow can quickly change direction and rather than watching your cash reservoir fill, you are suddenly watching it draw down and dry up.  But even worse, you are likely going to have to find other sources to keep the cash flowing to cover your obligations, like debt payments. 

While this concept is very simple, many investors (including myself) somehow managed to dismiss this basic principle of how money is made, and instead put complete faith in the rising tide of appreciation to more than cover our negative cash flows because real estate never goes down in value, right?   Today, we all know that the huge IF, as in "if real estate appreciates, we'll make money" was the silent killer.  (I'll be writing more about how IF will kill your business in another post).  Couple this with another silent killer IF, as in "if rental rates increase at least 5% annually", but they don't - and in fact rental rates sink, and you have yourself a serious cash flow problem. 

I learned this lesson personally, but fortunately not too painfully.  After spending what seemed like a lot of time looking at property (a huge time waster and backwards way to find investment property - yet another future topic of how I find, analyze, and purchase property), which only makes sense if you're looking for a personal residence, we purchased a studio condo in downtown Portland.  At first it was good.  Our rents were increasing.  Our tenants paid on time and left the place clean.  But we still weren't making money.  Our rental rate rose from $850 a month to $950 a month over two years.  We had some appreciation.  Then 2008 came.  The condo market got really soft (leaving us with no equity), the rental market took a dip (forcing us to bring rent down to $775), and HOA and property taxes continued to climb.  Ugh.  After taxes, we weren't losing much but there was no way out without walking away from our 20% down.  Selling would have left us with a zero net gain.  I mean, zero.  No cash to take home. This is an especially bitter pill to swallow when unclogging drains or performing other unsavory repairs, all the while remembering that I'm not making any money on this deal. 

Now, I always keep cash flow in the front of my mind because I like getting checks a lot more than writing them.