You can be a broke millionaire
That title may sound counter intuitive because how in the world could you be a millionaire and be broke, right? Well, today I’d like to tell you a story about a good friend of mine and explain how those two things can be possible.
Before we get started, I want to say I have permission to share this story with you because it has a really good lesson associated with it. My friend just asked that I keep his name private. So throughout the story, we will refer to him simply as JR.
JR is a full-time real estate investor of the mom-and-pop variety. He flips a couple of houses every year and owns enough rentals to need a small staff. His rentals bring in enough to almost pay for his personal needs. And the flips pay for the rest, plus the expenses of maintaining a staff and office.
JR bought most of his rentals before COVID. As such, he has lots of equity, and truth be told, it’s in the multi-million dollar range.
Having most of your personal expenses covered by rental income and having multi-millions in equity sounds impressive, right? Well, JR is struggling, and it’s not because he’s living a lavish lifestyle either. If you met JR on the street, you would notice he drives an old pickup, wears mismatched clothes from the thrift store and talks and acts with the good-humored respect and humble confidence of a good old country boy.
The reason JR is struggling is not from overspending. Instead, he has a cash flow problem that has come from just a few things going sour and snowballing. First, two out of his last three flips have not gone well. One of the bad ones sold for far less than he had anticipated, and the second is both over budget, to the tune of over $30k (he has had some crazy issues arise on that one), and over timeline. The last flip went well, but it has been on the market for a while and has not sold yet.
He told me that his agent said his house is one of the best houses on the market in that price range but it’s not moving because the housing market has slowed down quite a bit. He told me when you combine how much less the first house sold for and how much over budget he is on the second, he has brought in $55k less than he was anticipating. He said that’s almost 5 months of operating expenses for his company, which means they’re almost through their 6-month reserve.
When I asked him how things got this way, he told what had been going on in the background. He had been working on a deal with an out-of-state investor. The investor was going to partner with him on a few houses in the form of equity participation. This was going to convert some houses originally identified for resale into rental property. Not only was this going to allow JR to keep some more houses, but it was going to give a cash infusion.
JR told me that he had already done a few deals with this investor and felt confident the deal would go through. As such, he flipped the switch on the resale houses, converted them to rentals and went ahead and put tenants in place forgoing the flip income.
JR said that he started working on this deal with the investor over a year ago. The investor had some changeovers with their custodian that caused things to take longer, but through every conversation, it still sounded like it was a go. He said they even had the paperwork drawn up recently. But at the very last minute, months after he had expected to close this thing, the investor pulled out suddenly.
“This was bad,” he said. “I had been making plans, altering deals because that cash infusion was coming and even using reserves to purchase other deals. And now… we’re broke. And I have people depending on me for a paycheck.”
You can tell the stress is weighing on my friend.
I asked him what he was going to do and he told me, “Use what I have, to get what I need,” partly quoting Pete Fortunato and Bill Cook. What he planned to do was liquidate some rentals. He had two that were vacant, and he planned to do a flip-ready rehab and sell them, hopefully quickly.
So, what are the lessons here? First, having a multi-million dollar portfolio matters not if you can’t access that money. We call this “untapped equity.” And in order to access those funds, you need to either sell or leverage those units.
Since he was already having cashflow issues, he decided to forgo getting a loan on those houses and causing more monthly payments.
The next lesson here is flipping can go bad quickly. He had two deals that didn’t go well and one that’s just slow to sell. This is causing cash to flow away from JR and depleting him quickly. Diversification is a good idea even inside of real estate investing, which is why he flips and has rentals.
Finally, rental property has multiple profit centers. JR has been receiving positive monthly cashflow on those two rentals for years. Now he is going to get to tap into the growth center of those houses — which is where they’ve grown in value over time.
But the biggest lesson here is that you need to be mindful of cashflow. Things change, deals fall through, flips go bad or take longer than anticipated and investors pull out suddenly. And if you aren’t producing enough cashflow for your business to survive, you can go broke even if you have a multimillion-dollar portfolio.
I know JR is going to come out on top, but I don’t envy his stress level until he gets there.
Joe and Ashley English buy houses and mobile homes in Northwest Georgia. For more information or to ask a question, go to www.cashflowwithjoe.com or call Joe at 678-986-6813.