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Once upon a time, there was an ant and a grasshopper who lived in a beautiful meadow. The ant was a hardworking creature, always busy collecting food and storing it for the winter. The grasshopper, on the other hand, was carefree and loved to sing and dance all day long.
One bright summer day, the grasshopper was prancing around the meadow, singing a tune, when he noticed the ant working hard to gather food. The grasshopper laughed and asked the ant why he was working so hard on such a beautiful day. The ant simply replied, "I am gathering food for the winter. It is better to prepare for the future than to enjoy only the present."
The grasshopper thought this was silly and continued to dance around the meadow, ignoring the ant's advice. As the days grew shorter and the weather turned colder, the grasshopper started to feel hungry and realized he had no food stored for the winter.
The grasshopper went to the ant and begged for food, but the ant refused, reminding the grasshopper of his laziness and disregard for the future. The grasshopper was forced to spend the winter hungry and cold, regretting his foolish ways. The lesson here is clear: it is better to plan and prepare for the future than to live in the moment without regard for what may come.
Similarly, in real estate investing, investors (the ants) who focus on generating cash flow from their rental properties are like the ants consistently gathering their food (cash) and storing it for a potentially harsh winter (i.e pandemic, financial crisis, etc.). They receive a regular stream of income from their properties, which they can use to reinvest, save for a rainy day, or simply enjoy. By generating consistent cash flow from rental properties, real estate investors can build wealth over time, just like the ant who stored up food for the winter.
Cash flow is a crucial concept in investing, as it determines the amount of money that you can potentially earn from your investment. Essentially, it is the money you have left over after all the expenses and taxes are paid that is available to be distributed to investors. Being mindful of your cash flow is important because when you have positive cash flow, it means you have extra money left over that you can use for other things like saving, buying things you want, or even investing in more opportunities. It's like the ants having all the food and being able to worry about other things like telling the grasshoppers they should’ve been preparing.
Cash flow in real estate specifically looks at the money you're making from the property compared to the expenses you have to pay. The money coming in is usually from things like rent payments, income from additional services like laundry or parking and any other sources of income related to the property. The expenses include things like mortgage payments, property taxes, insurance, maintenance costs, reserves, and other costs associated with managing the property. By subtracting the expenses from the money coming in, you can determine the cash flow of the property. Positive cash flow in real estate means that the property is making more money than it costs to operate. This is beneficial because it allows you to earn income from the property, but there are certain things you should pay attention to when having cash flow.
Most people believe that a bird in the hand is worth two in the bush, or it is better to hold onto something one has than to risk losing it by trying to get something better. However, when it comes to investing in real estate, the more you have been paid back for an investment, the less chance you have of losing your total dollar amount. This is because cash flow is a tangible and consistent return on your investment, unlike speculative appreciation that may or may not materialize. For example:
Cash flow as a risk reduction and infinite growth potential: Cash flow serves as a risk mitigator by gradually paying back your initial investment. The more you receive in cash flow, the lower the risk of losing your entire investment. As the cash flow accumulates, there is a possibility of reaching a point where the income generated fully pays off the original amount you invested. Once this occurs, your investment can continue to grow infinitely, as you are no longer reliant on the initial capital. In the case of the Ant, the winter food pays back the extra effort/output from the summer months.
Cash flow's compounding effect over time: The longer you hold onto the cash flow generated by a real estate property, the more it has the potential to compound. Similar to ants diligently stacking food for the winter, the accumulated cash flow can grow exponentially as you continuously use the cash you earn to make more.
Cash flow in consideration of selling: Cash flow encompasses the ongoing income generated by the property, but it does not include the potential returns from selling the property. Selling a real estate property can provide a substantial return on investment by returning your initial capital along with any appreciation in the property's value, however you’d miss out on the steady stream of income.
Cash flow as an indicator of stability and demand: When a property consistently generates money, it shows that the property is valuable and lowers the chances of it becoming outdated or unused in the future. The fact that the property can consistently make money proves that it is profitable and people will want it. This stability and successful history not only makes the investor confident in the property's financial potential but also reduces the risks that come with changes in the market or shifts in demand.
Cash flow is one of the primary ways that investors can reap financial rewards from their real estate investments with a wide array of benefits.
Freedom to make decisions: Cash flow from a real estate property provides you with financial freedom and flexibility. When you have a positive cash flow, you are in control of your own financial destiny. You have the power to decide what to do with the surplus income generated by the property. Whether you choose to reinvest it back into the property for improvements, spend it on personal expenses, or save it for a rainy day, the choice is entirely yours. This ability to make decisions based on your own financial situation puts you in the driver's seat, allowing you to pursue your own goals and aspirations without being dependent on others.
Passive growth from cash flow: One of the significant benefits of cash flow in real estate is the passive growth it provides. When you own a property that generates consistent cash flow, you can enjoy the benefits of your investment working for you. While you may have put in the initial effort to acquire the property, the ongoing income can be largely passive depending on how involved you want to be and your willingness to pay others to manage it. This passive growth allows you to have a steady income stream while focusing on other aspects of your life hopefully leading to long-term financial stability.
Compounding effects of cash flow: Here it is again! Compounding! Positive cash flow has the potential to create a compounding effect that leads to higher growth. As you reinvest the surplus income generated by the property, such as through property improvements, upgrades, or acquiring additional investment properties, the overall cash flow increases. This increased cash flow can then be reinvested again, leading to a cycle of continuous growth and multiplying returns. Over time, the compounding effects of cash flow can significantly enhance the value of your real estate portfolio and accelerate your financial growth.
Cash flow may not be as exciting as real estate developments or value-add projects, which have the potential for outsized returns after you build or make improvements to the building in hope to sell it for a gain (reversion). These projects often require large amounts of capital and come with more risk. In contrast, cash flow investments typically involve stable, income-generating assets with lower risk. While cash flow may not provide the same thrill as a value-add project, it can offer a reliable source of income and a solid foundation for long-term wealth building.
In real estate investing, the concept of cash flow can be visualized as a steady stream of income generated by a property's tenants. It's important to consider the type of tenants occupying a property as their business models, and the industry they belong to, can impact the property's ability to produce consistent cash flow. For example, a family restaurant that has been in business for a long time and has a loyal customer base is less likely to vacate the premises, leading to a steady flow of rental income.
However, it's important to note that while a property's past cash flow history can be a good indicator of future performance, it's not always a guarantee. Changes in the market or the tenant's business can cause fluctuations in cash flow. Therefore, it's crucial to thoroughly analyze the property and the tenant's financials before making an investment decision. This analysis should include understanding the tenant's business model or in residential real estate their ability to pay rent, reviewing their financial statements, and assessing their industry outlook to determine the likelihood of consistent cash flow in the future.
In conclusion, Aesop's fable of the ant and grasshopper is highly applicable to the concept of cash flow in real estate investing. By generating steady cash flow, you are preparing for the future and building wealth over the long term. While there are some drawbacks to cash flow investing, it can be a powerful tool for building wealth and creating financial security. Ultimately, the key is to strike a balance between generating cash flow and seeking out new opportunities for growth and profit.
Rhea was scared stiff, her heart beating fast. Even though she was a mythical Greek Titan, she was terrified of what might happen if her husband found out she’d left their baby on the isle of Crete. Still, she stepped closer and held it together as much as she could.
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