Which Takes Priority: Return on Equity or Cash Flow?
Edit: I realize now that instead of "cash flow" I should have said "cash ROI". Either way, I'm still curious to hear thoughts on whether increasing leverage should be emphasized over increasing monthly income to the investor. Thanks!

Hi all, 

I am brand new to the world of real estate, but am interested in eventually obtaining a multifamily residential building and becoming a real estate investor. To this end, I have been reading a book by Steve Burges where he lays out the financial fundamentals of real estate investment. Early on he says multiple times that cash flow is an extremely important aspect of RE investment and orients all his examples to the maximization of cash flow. However, later on in a discussion of debt he provides an example of reducing investor equity from 25% to 10% and says that the subsequent drop in cash flow from $20k/month to  $17k/month is okay because reducing investor equity (and thereby reducing cash flow due to higher debt payments) has also increased return on investor equity. 

This confused me because I thought previously that cash flow was the main focus of a good investment, and now he is implying through this example that return on investor equity takes precedence. Can anyone provide me with some general knowledge or a rule of thumb as far as which one is better to focus on? As a risk averse person I would tend towards less debt (higher investor equity) and greater cash flow, but the idea of starting investment sooner by decreasing my equity invested is intriguing. Thanks in advance!
[{"id": "cjoqgzw", "text": "I imagine that he is viewing \"cash flow\" as the overall income generated by the property, which in my opinion I would agree is fundamentally the most important aspect of a commercial property. Where as the debt to equity ratio is an entirely different aspect altogether. Generally, any incoming producing property will be valued based on its net income, therefore maximum income should be what every investor strives for. How each investor balances their particular debt on a property is more of a personal preference and typically won't impact on value.", "replies": [{"id": "cjoyeac", "text": "I agree with everything you mentioned with the exception of debt having no impact on value. The cost of debt has a direct impact on real estate values. Cheap debt reduces the investor equity return hurdles. This is why current yields on commercial properties are so low. ", "replies": [{"id": "cjozfcg", "text": "Yes, I agree, which is why I said it typically doesn't affect the value. Although, I would argue that the interest rate charged on debt is an entirely different conversation altogether, as it would have an overarching influence on the entire market, all properties would see a general increase or decrease in value as lending rates decrease or increase respectively. \nHowever, where debt structure can impact a property value is restrictive covenants in the mortgage that limit a potential purchasers debt restructuring options. This can seriously impact the marketability of a property.", "replies": [], "depth": 3}], "depth": 2}, {"id": "cjoz6cp", "text": "Thanks for the reply, this helps me to put things in perspective. Intuitively it would make sense that increasing net income from the property should be the main goal for an investor, so I guess risk tolerance is what it comes down to in terms of deciding how much debt to take on and whether to invest the equity saved in another property.", "replies": [{"id": "cjup3sk", "text": "exactly, it's all about your appetite for risk/debt", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "cjozjez", "text": "Let's say you find and buy a property with a 10% cap rate. The property cost $100,000 and the NOI is $10,000. The 10% is your cash-on-cash return on an all cash investment because without debt service the NOI is also your cash flow.\n\nNow, let's get a $50k (50%) loan at 6%.\nNow your cash (equity) in the deal is $50,000, your NOI is still $10k, and debt service is $3000. So, your cash flow after debt service is $7000. Your cash-on-cash return just went up to 14%. Plus, you have $50,000 in your pocket with which you can buy another property. \n\nLet's say there's another condo unit available in the same building and you get the same deal. So now you have the $100k invested in two properties and you're getting a 14% cash-on-cash return, which means the cash flow to the investor is now $14,000 instead of $10,000. \n\n\n", "replies": [{"id": "cjozp22", "text": "Very well stated. ", "replies": [{"id": "cjoztjg", "text": "Thanks", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "cjplsqv", "text": "Depends on what your goals are. If you're running a fund or deal where you get paid on the return for hitting an IRR hurdle and your promote kicks in, you would of course care to structure the deal so the investors you report to get their targeted returns. That's when returns figures matter. But you have to keep in mind, you can't eat IRR. If you care about passive income, then cash is king. \n\nRegardless, cash should be in any analysis anyway. Since buildings basically always require leverage, it matters when the cashflow shortfalls happen and you could very well lose your whole investment to the lender at those times.", "replies": [], "depth": 1}]