In Search of Cash Flow

The Real Estate Espresso Podcast

In Search of Cash Flow

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Welcome to the Real Estate Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host Victor Menasce. On today’s show, we’re talking about different types of cashflow investments.

A few days ago on the podcast, we discussed the concept of four investment buckets. These are the safety bucket, cashflow bucket, growth bucket, and the speculative risk bucket. All investors should be considering these four categories when planning their allocation strategies.

Today, we will zero in exclusively on the cashflow bucket. Many companies have diversified income streams, which include elements from each of these four categories. However, investing in such a company does not necessarily satisfy your need in all four categories. A company’s asset allocation is separate from yours, unless you hold a controlling interest in the company. You need to be thoughtful about your asset allocation independent of the investments you are considering.

A small subset of companies can be classified as cashflow investments. A common example would be utility companies providing essential services like electricity, water, or natural gas to the public. Despite these companies operating under a monopoly within specific geographic regions, the payout and rate of return for the shareholders remains within a predictable range year after-year. Such companies tend to pay out most of their profits as dividends, making them among the safest investments in the stock market.

Bonds held to maturity, as well as loans, also fall into the cashflow investment category. However, they require a certain degree of risk tolerance. Currently, the risk-free rate of return, which is identified with government bonds, is approximately 4.25% in the US. If you factor in a 3% currency devaluation rate, you’re essentially earning 1.25% on your money. It’s crucial to evaluate whether such a rate matches your yield expectations.

If you’re seeking a higher yield, you might consider a higher risk loan or note. However, you must assess the risk of default and the additional security that comes with the loan. It could be backed by real estate or equipment with sufficient equity to ensure the return of capital in the event of a default.

Investing in income-producing real estate is yet another option. However, unless the property with low cap rate in today’s market is mortgaged at an attractive interest rate, the return on investment could be low. Industrial properties, storage assets, and properties with value add components might yield higher returns, especially with a bit of leverage.

Whether you choose publicly traded companies, bonds, or real estate, the key to any successful investment is the underlying team managing it. A well-managed good deal is far better than a poorly-managed great deal. Therefore, the deciding factor between two good deals is the quality of the management team.

The problem with bonds is their tendency to follow interest rates. We’ve had more than a decade of negative real interest rates, and unless you’re willing to take on additional risk, your rate of return is going to be interest rate sensitive.

Real estate can also be sensitive to interest rates, but if the property has locked in an attractive borrowing rate for an extended period, you can achieve an outsized return. Cash flowing assets should form part of a portfolio. What percentage that constitutes, of course, is entirely up to you.

As you think about these points, have an awesome rest of your day. Go make some great things happen! I’ll talk to you again tomorrow.

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