Know this about cash flow, risk and reward
Know this about cash flow, risk and reward
We can all agree that cash flow is going to be a great indication of whether you have made a “good” investment. To make sure you get there, let’s cover the basic math of real estate again
Hello! How are you, lover’s of real estate and pop culture and the tiny overlap in that very specific Venn diagram? March is upon us and spring has sprung and birds are singing and Covid is over … whom am I kidding. Between severe storms all over Europe, a quickly escalating war not that far away and exactly ZERO entertaining pop culture news, it feels like we are in an alarmingly dire drought of fun and fluff? Just me? No? Glad we at least all feel the same way about this odd moment in time. Opening up a newspaper really isn’t so easy these days which is why I applaud and understand your choice to turn to a real estate newsletter instead. Thanks for being here - I’ll try and distract you for a hot minute with something frivolous yet instructive (which is another veeeery small Venn diagram overlap).
In an attempt to escape, I actually went on vacation this week and while that obviously doesn’t mean that I will stop writing this newsletter, it did mean a stop to most other work I am doing, a flight to a much warmer country and the general joy of seeing something different for a change. What it also meant (and you can file this under “unintended consequences”) - coming face to face with a very venomous snake. What? I kid you not, coming home from dinner one night, I almost stepped on a puff adder. While it’s an unassuming looking little beast it’s also responsible for more snakebite fatalities on an entire continent than any of its colleagues. I wasn’t really that freaked out in the moment - but I couldn’t sleep that night and haven’t stopped thinking about the encounter ever since. So suffice to say the snake really rattled me (all puns intended). While my initial thoughts have revolved mostly around the question of whether the snake could somehow enter my hotel room, subsequent musings have been about risk and reward more generally (in quite a turn from the practical - snakes can’t open doors, can they? - to the philosophical). Was the vacation worth it, despite the possible risk of dying from necrosis? Absolutely. What does all of this have to do with this newsletter? Just you wait …
Several times since starting Rente aus Stein, I have had conversations with friends, acquaintances and perfect strangers that left me baffled. Yes, they have bought real estate, yes, they were feeling super good about it (whoever does real estate’s PR deserves a raise) - but when quizzed about the investment details, things became wobbly (to say the least). No one could readily recall specific numbers. I am shocked! Have we not learned anything in the last months of reading Rente aus Stein? How do you spend that much money on basically a hunch and the hope that what you just bought will turn out to be a good investment? How do you calculate risk and reward when it comes to such an enormous financial decision?
Sure, I understand, there’s a lot of factors to consider. Different variables work together to form a pretty complex calculation that could change drastically with just a few indicators moving ever so slightly. And, yes, more than once we have said that “it all depends”. Yet, there’s basics that don’t change, basics that you should probably be super familiar with before making a life-altering move. So, as a public service so to speak, we are dedicating March to the basics. Like repeating a grade in school to be ready for real life at the end of it, we are going to do three full editions on what we believe to be the basic math of any real estate investment. Not only so that you can recount your most important KPIs if some random writer from Germany asks about them. More so that you actually make a sound investment. The “talking about it later” part really only is the monetary cherry on top. What makes “a good investment”? What’s considered a “good” return or interest rate? We are gonna look into it all, with as much specificity as we can muster. Once more, for the people in the back.
Some of the stuff we are going to cover: Investment returns, obviously. We have done a pretty deep deep dive on that here and I’d recommend going back to that if you haven’t read it already. Your investment return is going to be the most important indication on whether you have succeeded in your investment or not, no rocket science in that one. Alas, you might not know the answer to the “how is my return” question for quite a long time, partially because your final return also depends on a potential appreciation in value of your asset. We’ll long be gone, sitting on a coconut tree populated but snake-free tropical island, sipping fancy cocktails decorated with tiny umbrellas and shiny straws by then. Which is why we think that cash flow - aka the money you have in the bank at the end of every month - is the best proxy to understand your investment and how it’s going. While this is a bit of a chicken and egg-situation (my cash flow is only going to be good if the return is good and vice versa) - understanding the levers of cash flow is critical in my opinion and you will need to calculate quite smartly at the very beginning to get to a great place. Turn a little here, flip a switch there and, voilà, a totally different outcome.
The three biggest players in this cash flow equation:
Your financing costs
Your repayment rate
Your rental income
While we think it’s worth looking at those three separately? Well, take the financing costs for example that we are going to tackle in more detail next week: Some are pretty obvious (like interest payments) but can still be tricky to negotiate because they depend on so many variables. Others are more obscure, like the lesser known and not always applicable disagio. We’ll cover all that, along with some model calculations to understand the vast difference even a few digits behind the comma can make (it’s wild!) and our number one mistake to avoid on the repayment side. Because the bottom line is this: as you are trying to calculate your risk and reward, it’s super important to honestly look at your financial situation as well as your life goals - what can you afford (like, really afford - without any vacation induced daydreaming) and how much risk can you safely take without endangering your life (maybe not puff adder-style, but you know what I mean)? We’ll help you do exactly that, specifically because we weren’t very good at it the first time around but learned a ton that we are happy to share.
Speaking of risk and reward: I fully realize that March means you will have to get a subscription to Rente aus Stein to read the details on how it all comes together as we have taken the risk to go paid with this thing. I love writing it and I love knowing that it helps in your real estate adventure - so thanks so much to those of you that have already subscribed, it really does mean the world. For everyone else, please consider subscribing now to make sure you are not missing important info for your real estate journey and to support our work. I really hope that there’s still something you can take away from our free monthly post if you are looking to invest - the importance of the right calculation at the beginning and how to bring together the three most important factors (see above) as you do for example. But if you mean it, I think you better take the plunge. Only hearing back from us in a month or so feels like too big a risk to take :)
Next time, on Rente aus Stein: We are diving deep into all you need to know to make sure you don’t spend too much on financing costs, seeing that they are an important lever in your cash flow calculation. You will need a subscription to read it, so please subscribe now to read all that and more for a few Euros a month!
Disclaimer: We are not lawyers (sadly) and as such can’t give you legal and/or tax advice. We are simply telling our story in the hope that it’s inspiring to you.