Part 2 – Converting Net Worth into Cash Flow

by FI Fighter on May 28, 2018

in Financial Independence

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A few years ago, I wrote a blog post titled — Converting Net Worth into Cash Flow. I think that article was somewhat controversial then, and perhaps it still is to a large degree today… The reason being? Well, when it comes right down to it, when we are talking about the subject of early FI, without question, the popular consensus and narrative out there across the blogosphere (and other media outlets) is that at the end of the day, cash flow reigns supreme…

Now, I’m not gonna go ahead and dispute that, per se, but as usual, I think the devil is in the details… and we need to deep dive into things to see how all the pieces are connected.

For myself, I had one of my many lightbulb moments around 2014 (I forget the exact date), when I was attending a local real estate meet up (which I loved to do back in the day) and chatted with a few high net worth individuals… Through our discussions, I got to pick their brains and learn many things… One profound connection that I put together (eventually) was that although the personalities from each person varied to a large degree, a common denominator with these folks was this:

 

They all owned very HIGH QUALITY assets that were also coveted by other high net worth individuals.

 

Now, the above “revelation” that I made might not seem like a big deal at all to you, but I assure you, that distinction that I ultimately put together is what helped me not only to achieve early FI, but more importantly, sustain it.

Around mid 2014/early 2015, I was still heavily active in the real estate scene and buying up rental properties, as many readers will be able to recall… Both consciously (and somewhat subconsciously) I had already heard the above message loud and clear, as I elected to deviate from my new strategy of focusing on building up a portfolio comprised of low appreciation but “better” cash flowing Midwest properties to again prioritize buying up high appreciation but “lower” cash flowing Bay Area properties (my original plan)…

You know, looking back, I don’t think this blog was ever more popular than it was around 2013-2014, when I was a large proponent of Turnkey Investing and focusing on: cash flow, cash flow, cash flow…

However, as I’ve learned over the years, just because a strategy is popular and accepted by the masses, it doesn’t mean that it’s the right one to employ… In fact, if I had to lay it all out there for you at this very moment, I would go on to say this:

 

Turnkey Turkey Investing was the single greatest mistake that I ever made in my investing career! I sacrificed many wonderful buying opportunities by being entirely too myopic, chasing after mediocre (to outright disastrous) cash flow deals.

 

Again, it all points back to the statement made above, the common denominator and glue that connected these very astute (not to mention filthy rich) investors…

 

They all owned very HIGH QUALITY assets that were coveted by other high net worth individuals.

 

Trust me on this — Turnkey Turkey Investing is NOT that!

 

Back in my younger days, I was too naive and short-sighted to ask some very basic (but important) questions…

 

“If some of the wealthiest people that I know in real estate aren’t chasing after the same out of state turnkey turkey deals that I’m fawning over, why is that?”

 

“Why is it that these people who can easily afford to go out of state and buy 10-20 properties ALL CASH, have ZERO interest in doing so… yet keep on electing to buy up more expensive Bay Area properties that offer what appears to be pathetic monthly cash flow?”

 

“Why are these people violating and completely ignoring the 1% Rule (in retrospect, I’ve learned that this is quite possibly the dumbest rule out there in real estate)?”

 

Because at the end of the day, it’s all about: Quality, quality, quality…

 

High net worth individuals don’t waste their time targeting after junk assets… So why should you? Why should I?

 

It’s newbies and uneducated retail investors who elect to chase after cash flow with reckless abandon, without any consideration for anything else… which I’m learning first-hand can actually be a very dangerous landmine that can completely derail (rekt) your early FI dreams… particularly as it pertains to Real Estate Investing. Worth noting is this very important distinction between stocks and real estate — Stocks can’t go below zero… Real estate can… and junk assets often do (e.g. expensive repairs, city violations, attorney fees, etc.)! With HIGH Quality real estate, you ALWAYS have an exit strategy… With shit properties, you could easily end up trapped in Hotel California… Sometimes the only way out, is to sell at a substantial loss!!!

 

In my own case, fast forward to the here and now (today), and it’s never been more obvious to me what a wonderful decision it was for me to load up on Bay Area properties… and what a shot in the foot I gave to myself in attempting to go out of state and extract as much cash flow as possible via overpriced and pathetically low quality turnkey turkey investments…

 

By focusing entirely too much on cash flow, at the end of the day, I ended up earning even less cash flow from my terrible out of state turnkey turkey investments…

 

Ironically enough, it’s my Bay Area properties that are my real cash cows… and the gifts that keep on giving.

 

So, naturally with those type of real-life experiences… my thinking has been altered significantly over the years…

 

On this blog, since about 2015, there has been a major focus on alternative investments (for a reason)… No, it’s not because I want to be contrarian just for the sake of being contrarian… but it’s because I’ve learned:

 

You have to go where the opportunity is.

 

It’s not about going against the crowds and trying to outsmart the markets… It’s about being a fan of opportunity… and an agnostic investor… I don’t swear allegiance to any single asset class… If something is grossly overpriced, I’m not going to be talking about it, or actively pursuing it… On the other hand, if we have a scenario like in late 2015/early 2016 when mining stocks were obliterated and completely hated by everyone, well, it’s something that’s always going to appeal to a guy like me…

If I’m gonna be burned by investing, I’d prefer that it happen when I’m attempting to buy HIGH QUALITY assets at freekin low firesale prices… I realize a lot of the things I ramble on about incessantly make little to zero sense to the masses, but I would like to believe that there is a method to the madness… Earlier this year, the culmination of a lot of hard work, research, and persistence paid off when my mining stocks portfolio eclipsed $1 million in gains (unrealized + realized)…

Now I have enough cash on hand to be able to pay off all my debts and remaining mortgages on my rental properties… which was kind of the goal all along with that “crazy” speculation…

Yes, it was an alternate route I took (some would argue to the insane asylum), but this all ties together back to cash flow… which is ultimately the “name of the game”… Yes, I still agree with all that, but like I said from the beginning of this article, the devil is in the details…

And importantly, with very speculative things, there are never any guarantees, and I must have looked like a total idiot to everyone on here when I was documenting my mining stocks journey in real-time… and having to painfully disclose the ugly details when everything kept on continuing to crash and burn… more and more… everyday… into record low territory

With that experience in my back pocket, I will continue to emphasize this:

 

When in doubt, stick to accumulating the HIGHEST QUALITY assets… You want to own what other affluent people covet…

 

  • With real estate, I want to own rental properties in the BEST locations where all the $200k/year high salary folks want to live and raise their families.
  • With mining stocks, I want to own the BEST mineral deposits out there that are prime takeover candidates for a major producer.
  • With cryptos, I want to own the BEST projects out there that have the strongest teams backing them with very good odds of building a robust and sustainable “network effect” on their platform.
  • Etc.

 

As for turnkey turkey rental properties, by and large, these operators/salesman can only make real $$$ flipping overpriced dogshit properties to out of state newb investors (there’s a good reason the local investors don’t touch these products)… It’s tough to generalize, but I wouldn’t waste my time at all dabbling in this space (knowing what I know now) since the odds of long-term success are minuscule, at best… Certainly, affluent investors don’t covet these properties at all…

 

The caveat is — You want to be able to buy HIGH QUALITY assets at a low price. Get the most bang for your buck. That’s really the only way I know of to shortcut the early FI journey…

 

 

It’s not easy, but if you can succeed, then it makes perfect sense (after the fact), to eventually book your profits so that you can finally swap back and into everyone’s favorite Buy and Hold Forever type of assets… The investments that you deep-down wanted to own from the very beginning.

 

I’m not a hater of dividend stocks, index funds, even expensive Class A real estate… As I already pointed out, my Bay Area properties were the best investment decisions that I ever made in my life… But at today’s current prices (2-3x more than what I originally paid), I just don’t think it does any good for me to ramble on and on about what a buying opportunity they are TODAY for anyone reading this… because at record high valuations, they CLEARLY are not cheap!

 

But if you can make explosive gains elsewhere, and want to redeploy proceeds back into “overpriced” dividend stocks, index funds, Class A real estate, more power to you… I think that’s an awesome strategy… Actually, that’s something that I will probably elect to do myself, because at the end of the day, again, it’s all about cash flow, particularly via the HIGHEST QUALITY assets out there…

 

Look, building up a dividend portfolio that is worth $1-2 million, brick by brick, is no small task for most people out there… but if you can take a shortcut there, then why the hell not? I love dividend stocks (believe it or not)… They are truly 100% passive. For a life in early FI, you can’t beat that!

 

But in today’s challenging investing environment where most assets are in bubble territory, I just think it makes more sense for the early FI enthusiasts out there to focus more on building up net worth first and foremost… because you can always convert that to cash flow later.

 

But the other way around? It doesn’t work so well…

 

As i learned the hard way with my turnkey turkey rental properties…

 

What a most painful lesson, indeed…

{ 7 comments… read them below or add one }

1 JohnNo Gravatar May 28, 2018 at 1:32 pm

Stop churning out quality content faster than I can read :D. Great post

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2 FI FighterNo Gravatar May 28, 2018 at 1:57 pm

John,

LOL, when are you ever working? One has to wonder…

Reply

3 georgehpuckNo Gravatar May 28, 2018 at 7:40 pm

FI, I have to disagree with you a little on the whole cash flow thing.

While I agree the outsized gains come from property appreciation, value add forced appreciation etc. Cash flow pays the bills, its that cash flow that gets you thru the tough times

For one you bought your real estate in one of the most volatile real estate markets in the country. I can think of 3 if not 4 major corrections in California real estate.

And you bought near the bottom and are by all accounts we are getting closer to the top, if not a correction in real estate. SO yes class “A” real estate has made you a ton of money, you also did some nice work with rehabs that gave you forced appreciation etc.

You haven’t been thru a correction with those properties yet. Now I am not suggesting doom and gloom, far from it, but the price appreciation my stop for a while, and newbies who are just getting in could get burned badly if they ignore the 1% (and other cash return rules), to put money down on one spin of the cash appreciation roulette wheel.

I expect you will see a bigger drop in prices in the “a” properties around the country AND especially in the Bay area during the next downturn. My reasoning is that if tech gets hit, as it did in say 2000, you will see a significant downturn in what people can pay for rentals.

That’s what the 1% (or 2%) rule is about, its a rough indicator to use as a filter, and gets you to roughly a 10-12$ return.

But the 1% rule is like a PE ratio in the stock market imo. (only in reverse), if a stock is trading at 8x’s earnings, it looks cheap, and warrants further investigation, just like a 1% or 2% rule house does.

The problem is a PE ratio (price/earnings ratio) gets low if either the price is low, or the earnings are high. SO if a stock is at 8x’s earnings, it might be that the market is telling you the earnings are about to go from say $1.00/share to $0.10/share, your forward PE ratio might not be 8x’s, it might be 80x’s.

Similarly, the 1%, or more commonly mentioned 2% rule might be telling you that the neighborhood is stagnantor a flat out war zone, with no chance of appreciation. the rule does work better in the Midwest, because property values haven’t shot up nearly as high as they have on the coasts.

In Dallas where we invest, the 1% rule absolutely is an important number. We have an abundance of high end class “a” multi family apartments (+2,000+), and there are some reports that part of the market is getting soft with 2 or 3 year old apartment complex’s giving specials, free rent and other move in specials.

And yes, I avoid 2% markets because generally they are neighborhoods and cities where the population is in decline.

It sounds like from reading between the lines of your blog something may have happened with one of your out of state turnkey properties. And that sucks, I hope it gets worked out.

I do agree with you that people have to be careful of turnkey properties, you are essentially buying the construction quality, ethics, property management and cash flow of a property that you are buying at market price in a part of the country with little to no growth.

I think that is a really really tough asset to own, unless you have an honest company and plan to hold for 20-30 years.

We personally have done best when we buy “c” properties that are in the path of progress and can realistically move to a class B, or possibly even a class A property over time.

I don’t think we are that much in disagreement, property appreciation IS where you make your money. But at the same time, not ever market is like the Bay Area where price appreciation has been so drastic. And I worry that people who are getting into the FI game now, and charge headlong into Bay Areas real estate may wish they had more cash flow. Especially if we get a downturn in the market.

When I listen to the podcasts, the guys who lived thru the financial crisis seem to all talk about the importance of cash flow.

Cheers

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4 FI FighterNo Gravatar May 28, 2018 at 8:48 pm

George,

I am not dismissing the importance of cash flow, as my overall conclusion is that cash flow is key to early FI… What I am saying is investors can easily get too myopic (like I did) and put too much weight and importance on Day 1 cash flow above all else… That is a huge recipe for mediocrity and in some cases epic failure… I know from first-hand experience!

With that said, I would never suggest anyone chase even the best Class A rentals at sky high record valuations either…. which is EXACTLY why i am NOT an advocate of anyone getting into Bay Area rentals right now… If I wasn’t clear on that point, I will restate it again — Paying a premium for any asset class is high risk! I stopped buying Bay Area real estate in 2015 as it eclipsed the maximum price I was willing to pay. I stand by that decision even today to stop buying.

There’s a reason I shifted my focus to mining stocks, that sector was totally beaten up and undervalued… With the profits, I have no qualms putting that capital back into high quality cash flowing investments that are better suited for the buy and hold forever model.

I’m not saying I have all the answers, but I see far too many newbies to early FI chasing after mediocre “cash flow investments” like junk turnkey rentals that are a losing proposition in the long run… Ideally, one can buy the best high quality assets at firesale prices, but as we know today, that’s not always possible…

Definitely, I share the same concerns with you in regards to the high risk nature of Class A rentals today (particularly in the Bay Area) which is why I don’t like to talk about real estate so much anymore on this blog… If it was cheap, I would be harping on REI all day long, but where prices are today, I honestly just feel like there are better opportunities found in other asset classes.

It’s not easy for sure… but I would stick to Class A over Class C any day of the week… Bottom line, they are just a lot easier to sell and liquidate (should that need ever arise). not to mention, a lot less hassle to source high quality tenants.

All the best!

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5 FI FighterNo Gravatar May 28, 2018 at 9:01 pm

One further comment in regards to my Bay Area rentals — The price appreciation is nice in the sense that it gives me a clear cut exit strategy… But to be perfectly clear, the main purpose of those rentals are to generate cash flow and they do so in a matter that far exceeds what I’ve been able to get out of state. In other words, the rent appreciation (which is highly correlated with price appreciation) has outperformed even my wildest dreams. That’s the power of price appreciation… which is correlated to the best schools, employment centers, amenities, etc. My own belief is if you want substantial cash flow via rental properties, focus on QUALITY, which is not surprisingly also linked to price appreciation…. It’s almost funny how that all works out but also quite elegant and simple when you think about it.

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6 LaneNo Gravatar May 28, 2018 at 9:59 pm

I totally agree that Turkey rentals are not the answer but is a good starting point for new investors to get off the jacked up wall street train.

But I disagree with going for the “best assets” because unsophisticated money chases these deals and inflates their purchase price. If you have an experience you can invest in undervalued value add Class C and B assets as long as you have a capped time horizon. This is why I like to look for 1975-1990 properties because our business plan is the squeeze out the last of the value of these properties with still having high single digits of cashflow as the hedge to a downward turn in the economy. You can’t really do much with a 1960’s property. You really have to go through 500-1000 deals to find one of these and you are not going to find these being in the game with only 6 months of experience and no track record. This model is not infinitely scalable (and too small for the institutions to bother with) but what small sophisticated investors are quietly doing in the 2-8 million dollar asset range.

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7 FI FighterNo Gravatar May 28, 2018 at 10:26 pm

Lane,

It’s a very opinionated topic and extremely tough to generalize as you well know, but all things considered, at the end of the day if I could re-do my decision to go out of state and buy turnkey rentals, I feel 100% confident I would have been better off just sticking to 100% passive dividend stocks/index funds.

Out of state investing, and Class B/C as you mentioned can be profitable but I deep down honestly feel that those type of properties are best served for local investors who have “boots on the ground” and can handle any issues that pop up. For out of state investors, it’s a very tough proposition b/c unless you have close friends/family in the area, your PM is going to charge you an arm and a leg for every little service, no matter how minor it is… For out of state investing, again I’m generalizing, I feel like Class A is the best strategy for out of state investors just for the easy resale exit strategy and better client pool of tenants to choose from.

Yes, it can work, but for anyone who is extremely lazy like me and doesn’t want to deal with rentals at all in early FI, I would stick to Class A or dabble in other asset classes until Class A prices come back down to earth.

Just my personal take… Thanks for sharing your own experiences, thoughts.

Cheers!

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