What The New York Times Does Not Understand About Real Estate Cash Flow

The New York Times recently published an article discussing the performance of land and real estate over the past 100 years. Their premise was that neither land nor real estate has been particularly profitable over this time frame. In fact, neither has kept up with inflation or the time-value of money.  On the surface, they are absolutely correct. But when we look at the same scenario from an investor’s perspective, they are totally missing the point of what makes real estate such a great investment vehicle – cash flow.  

That’s right, cash flow.  

The Times articles was focused purely on appreciation, which does not totally apply to wise investors who focus on cash flow.  To be honest, we agree with the article, relying on appreciation for a real estate investment will leave you high and dry.

Why?

Because it’s fake.

That’s right, it’s all made up anyway. The price of real estate, like any other fixed asset, is not always based on its true (nominal) value. Instead, prices are based on market economics. Supply and demand. Simply, what someone else is willing to pay for it.

So just because someone is willing to pay and arm and a leg for a house, doesn’t mean it’s worth it. Similarly, just because a property sells for pennies, that does not erode its intrinsic value.

A bit confusing at first, but if you think about it, it actually works in the investor’s favor – in the latter case anyway.

We’re taking you back to Econ for this one, stay with us.

In raw numbers, land and property cannot keep pace with inflation or a rising GDP (gross domestic product). The article states that the real United States GDP grew 15.5 times over the last 100 years but housing and land only grew 1.8 and 3.1 times.

GDP is how productive the society is and the economic value of what was produced. That means that today’s economy is 15 TIMES more awesome economically productive than it was 100 years ago.

Why does this happen?

Mostly due to supply and demand, according to the article. Like any other commodity, as prices (demand) increases, the market will supply more inventory (builders will build more houses). This keeps pricing in balance so there is not a surge in home prices.

Ok, so what does this mean for the would-be investor?

Focus on cash flow

If you owned a piece of property 100 years ago that showed solid fundamentals, you’d have had 90-95 years of debt-free cash flow. Yup.

As investors, we make our money on the monthly return not appreciation. We think of our rental houses as little monopoly houses that give us a return every month. They are basically individual franchises of our savings account (down payment capital) that pays monthly interest (rent) every month.

Look for mega-trends to inform your investing choices

Time to open those eyes. When investing for cash flow, potential residents have to have jobs and amenities that make your property desirable. What trends are happening now that you can capitalize upon?

For example, there is an “urban renewal” happening in many cities. Baby boomers are giving up their sprawling suburban mansions for the convenience of a smaller, urban footprint. Is your portfolio set up for this shift in housing behavior?

Maybe you should consider a mix of single family homes in first ring suburbs of reliable middle class cities. Places that are boring. No booms, no busts, just everyday working class people who can put money in your pocket month in and month out.

Location, Location, Location is still true

The article references the rise in services as it relates to the value of real estate. Having access to amenities like good schools, entertainment and stable employment are essential to resident happiness. When deciding on where to buy property, are you looking in a bedroom community or an area of town that has easy access to industrial corridors where jobs will be plentiful?

An aside…We love cash producing real estate, but it is painfully obvious in the article that GDP was the real winner over the last century. With that in mind, how can you fuel your life with a business in tandem with your real estate venture?

Cash producing real estate is a great investment as long as it actually is cash. producing.

On its own, real estate appreciation is not a reliable way to build wealth because when averaged out over the long-term, the increase in values do not even keep pace with inflation.

We suggest making prudent investments in locations that can produce consistent, steady returns.

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