Cash Flow Business Tip of the Week: Buying Cash Flows: An Explanation for Skeptics

Positive-Cash-FlowA popular topic among calculator “wonks” and knowledgeable note brokers is how to make money buying rental income. An idea first suggested by Note Educator Howard Cook years ago has turned into a lucrative way to earn a 43% yield.

You offer to give an apartment owner a lump sum of cash if she will sell you the rental income from one tenant for one year. In return, you get a 20% discount. Many owners like the idea because with the cash they can fix up the other apartments in their complex and raise all the tenant’s rents.

For example, if the normal rent is $1000 per month, you offer $9,600 in a lump sum for the right to receive the tenant’s $1,000 rent for the next 12 months. $12,000 less 20% is $9,600. It looks like this on your financial calculator.

NIPMTPVFVComment
1243.34%$1,0000($9,600)$0Your yield is 43.34% on your $9,600 investment.

As I  discuss this concept with investor groups, I find a few people are skeptical, particularly those with math backgrounds. They simply don’t believe the numbers. They try to add up the payments or play with “markup” and percent increases. Conceptually it is difficult for some people to grasp the Time Value of Money.

Many times it is futile to explain why it works. But we should all be encouraged that the Time Value of Money is confusing; that’s how note brokers make a profit. For those willing to follow WHY this works, I explain it this way.

You could borrow the $9,600 on your credit card at 13% interest, then buy the rental income and earn 43.34% interest and make a profit of $142.51 per month. This works because the credit card company earns 13% in exactly the same way we earn the 43.34%.

NIPMTPVFVComment
1213%$857.49($9,600)$0You will pay off the credit card in 12 $857.49 payments.

In short, you receive $1,000 per month from the tenant and pay the credit card company $857.49 each month for a profit of $142.51 each month; and you put none of your own money into the deal. The Time Value of Money calculations are the same in both cases.
Any attempt to add, or subtract or multiply the payments by the number of payments ignores the time value of on your investment. It is a powerful concept and profitable to those who use and understand it. Can you think of a way to use this idea to repay your own debt?

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