Sometimes the best lessons are cautionary tales when it comes to business, investing and tax planning. This is a true story of what can happen if your strategy doesn’t match your current situation.
I had my first phone consultation with a possible new year-round tax client a few months ago. They were a busy couple. The husband worked two jobs and the wife work full-time while she went to school. They had a growing family and lived in an expensive part of the country. The plan for their real estate was to create passive income so that the husband could go back to just one job.
They already had a couple of real estate investments, but the money wasn’t flowing to them. How come they weren’t rich?
As I started looking at their properties, though, it was pretty easy to see what one of their problems was. They had 3 properties, each of which had a negative cash flow of $500 – $1,500 per month. They were paying over $3,000 per month just to hold the properties. Reverse that negative cash flow and it wouldn’t be long until hubby could quit his job.
As we talked, I got even more excited for them. They had substantial equity in the rental properties because the properties had appreciated. We estimated that they could get about $400,000 cash in their pocket if they sold.
With a decent cash on cash return (COCR) of just 10%, they’d have $40,000 per year of income. Considering they were losing almost $40,000 per year with their current plan, making this change would mean a net difference of $80,000.
Hubby could definitely quit his second job!
I was happy to explain my plan to them. Silence.
That was puzzling. I asked if they had any concerns. The wife hemmed and hawed and then said that they didn’t want to sell these properties because they wanted to keep them for their now preschool children to have one day.
I had a number of thoughts, but I needed to choose my words carefully. The things I wanted to ask, in rapid fire, were something like:
I thought you wanted passive income. Do you want something that your kids may or may not want instead now?
How about getting properties that cash flow to give them so they can decide where they want to live?
What if your kids don’t want these houses?
Do you think maybe having a less-stressed-out set of parents is worth more than a group of white elephant houses that MAY have more value down the road?
In the end, they listened to my plan and said they were going to talk about it. They’d get back to me in a week.
They didn’t become clients. They wanted to keep those houses and didn’t feel I was on board with their real goal of hubby quitting his job while they kept negative cash-flowing properties.
**The Cash on Cash Return (COCR) calculation mentioned above is calculated by dividing the annual cash flow by your cash investment. In the quick calculation I did, I assumed that you could buy properties for $400,000 out of pocket. There would likely be a loan (the $400,000 is the down payment), but the loan payments then are calculated as part of the annual cash flow. You’re out of pocket just $400,000.
The annual cash flow is the gross rent less mortgage payment, HOA dues, insurance, property tax and repairs.
Make sure you’re clear about your goals before you start your business or investing. It’s okay to change your mind, but if you want success you need to be crystal clear as to what you want and make sure you’re following a path that will to get you to that success.