HOW I VIEW NEGATIVE CASH-FLOW:

There are two types of real estate purchase areas: negative cash flow and positive cash flow. For example, if you buy a three bedroom house in San Francisco for $800,000 with 20% down and rent it for $2500 per month, assuming an interest only teaser starting rate of 4%, you will start with a $2400 per month negative cash flow.

Now, that same house in Phoenix at $150,000 (example only) with 20% down and a 4% teaser rate may rent for $1100 per month providing a $527 per month positive cash flow. The first purchase requires a down payment of $160,000 while the second only $30,000 down.

The house in Phoenix yields a 21% cash-on-cash return ($527 x 12 divided by 30,000 = 21%). However, in two years, the house in San Francisco may sell for $975,000 providing a much greater two year total return or internal rate of return (IRR) of approximately 75% over 24 months. It’s simply referred to as the “trade-off.”

Here’s the key: San Francisco has always been a negative cash flow city and it has done nothing to prevent people from making a lot of money because of the “trade” for upside potential. That’s where we are with Scottsdale and other parts of the county in 2006. And, that is not a bad thing at all! It’s similar to buying growth stocks that pay no dividends, but have the potential to double and triple. It says our market is becoming more sophisticated.

Example:
In 1990, I purchased a single family house (SFR): On a Sunday afternoon walk in the Sunset District of San Francisco, the owners of this house held an open house. My fiancée (now wife) and I lived close by. We took a look inside and there was quite a bit of activity. The seller was a real estate broker who lived across the street and had purchased it from the owner’s family after she had died. Although the asking price was $350,000, there was Rachel offering $325,000 on my behalf with my money! I put down $65,000 and financed $260,000 with a COFI loan. When I ran an ad to rent the house, a threesome came to look and take measurements. Then they let me know that they were a spiritual group of 50 and would use the house as their meeting center. Although they wanted a ten year lease, I gave them a three year lease to start. This past May began their seventeenth year, with the rent currently at $2,200. The original rent was $1,400 and my PITI was $2,400 for a $1,000 per month negative cash-flow. Today, my PITI is $1,738 and the rent level of $2,200 provides positive cash-flow of $462 per month. Current market value: $1,190,000.