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Rental Property Doesn’t Cash Flow? What to Do If You Own a Dud

Expertise: Mortgages & Creative Financing, Business Management, Landlording & Rental Properties, Commercial Real Estate, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Personal Development
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Just as every seasoned flipper has lost money here and there, every buy and hold investor has bought a property that just doesn't cash flow.

We recently repositioned an apartment we had owned for quite a while with the hope that the units could rent for $895/month. Unfortunately, the apartment was right on the edge of two neighborhoods, and the lower quality one won out. We only got between $695 and $750/month.

While this apartment still cash flows at those rents, most often when you miss by as much as we did on that occasion, the property will not cash flow. Indeed, in some markets—particularly on the coasts—it's all but impossible to get a property to cash flow (with a loan on it, at least).

So, You Aren’t Cash Flow Positive—What Now?

The first thing to do in such a situation is to take the emotion out of it. Who cares if you feel ashamed of a bad purchase and think you should dump it no matter the cost? Or who cares if you really love the property and feel like you should keep it no matter what?

In business, we need to think calmly and rationally. So, we start with the dispassionate questions:

  1. Does the property actually not cash flow?
  2. Is it temporary?
  3. Is it fixable?
  4. Is it tolerable?

Let’s delve deeper into each.

1) Does the Property Actually Not Cash Flow?

This is a question that can be approached from two sides. If a property just barely cash flows while occupied, then it doesn’t actually cash flow. Eventually, the property will become vacant, and that loss needs to be accounted for on whatever cash flow analysis you put together.

The rule of thumb is 10%, but it depends on your market.

In addition, the property will require capital expenditures from time to time (like a new roof). These need to be accounted for as “recurring capital expenditures” or “replacement reserves” (as Wall Street calls it).

raising-capital

Furthermore, if a property just barely cash flows after taking vacancy and recurring capital expenditures into account, it should be viewed as highly suspect.

On the other hand, you may have a property that just had a bad year. For example, if you own a fourplex and had a wave of moveouts and capital expenses, it may just be an anomaly. Under normal circumstances, the property would cash flow just fine.

Figuring out what is actually going on will require digging into the numbers and working out why it isn’t (or is) cash flowing to determine whether this is a structural issue or not.

2) Is It Temporary?

As I write this, we are in the middle of the coronavirus outbreak and resulting economic turmoil. Black swan events are difficult to predict and can make normal business operations go completely haywire.

One estimate concluded that one-third of apartment renters didn’t pay their rent in April. While we haven’t seen anything even close to that, these are still obviously tough times.

The question you need to ask is whether the property can cash flow under normal circumstances. Also, consider how long you can accept the current losses you’re experiencing, given we don’t know how long this abnormal situation will last.

If the property was cash flowing prior to this crisis, it will likely continue after the crisis has abated (whenever that will be).

Related: Landlord Emergency Preparedness 101: What Real Estate Investors Should Do Before Disaster Strikes

3) Is It Fixable?

A property that doesn’t cash flow might not be stuck in such a situation.

Some owners, unfortunately, like to cheap out on everything. Oftentimes, this leads to a bad tenant base that won’t pay rent and will trash the units. Simply upgrading the property could fix the situation.

Or perhaps there’s something more creative that can be done. Can the property be rented to students for a higher monthly rate? Or can it be used for military or corporate housing? Maybe try Section 8?

realtor giving house keys to homeowners

Can you add an accessory dwelling unit (ADU) or turn it into a duplex? Can you subdivide the back lot and sell that? Can you chargeback the utilities?

Could you make some alterations and increase the rent enough to offset the cost? For example, is there any potential for a garage conversion, attic conversion, adding a bedroom or bathroom, building a fence in the backyard, etc.?

These are possibilities you should consider before making a decision.

Related: 13 Proactive Ways to Increase Rent & Add Value to Your Rental Property

4) Is It Tolerable?

“Negative cash flow should never be tolerated!” I hear the critics yelling.

Well, true enough. But you already own the property. What’s done is done, and every decision has tradeoffs.

If you have a decent-sized portfolio, it might make more sense to hold than to sell. That decision is based on the market.

Determining the Best Course of Action

Ask these questions next:

  1. Can you refinance your way to cash flow?
  2. Is there big upside potential?
  3. Should you sell?

Again, in each of these instances, dig deeper.

1) Can You Refinance Your Way to Cash Flow?

This isn’t common, but with rates at historic lows, refinancing might be a solution in some cases. This is especially true if you have a high interest private or hard money loan on the property.

We've had bank loans in the high-5s before; right now we can refinance in the low- to high-4s. Needless to say, that type of change in interest rate can have a major effect on cash flow.

2) Is There a Big Upside Potential?

It's sometimes been said that the difference between investing and speculation is that investing brings in cash flow. Appreciation is a bonus, whereas speculation is simply relying on appreciation. This is, however, simplistic.

Thoughtful hopeful African American employee looking at computer laptop screen, waiting hoping, person holding hands in praying position, expecting trouble solution, positive result, close up portrait

Speculation, in my opinion, is more like when you are blindly hoping for appreciation.

If you buy a property across the street from a site where a major mixed-use development is being built, you can be pretty sure it will soon appreciate considerably.

One example I provided previously was from David Lindahl’s book Emerging Real Estate Markets:

“If you had looked at a map of Southern California 40 years ago, you would have seen that Los Angeles and San Diego were the two largest cities. Between these two giants were hundreds of smaller cities and towns, and millions of acres of farms, orange groves, and undeveloped land.

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“The Path of Progress indicated that soon there would be little bare land between these two great cities, 120 miles apart. Los Angeles and Long Beach moved south, and San Diego moved north. Huge fortunes were made by investors who followed the Path of Progress.

“One man, Donald Bren, became a billionaire by buying up thousands of acres of bare land in a once-sleepy agricultural county called Orange County. Orange County was smack dab in the middle of this Path of Progress equidistant between Los Angeles and San Diego.”

So, if you are in the “Path of Progress” and there is a very good reason to believe that your property will soon appreciate substantially, tolerating negative cash flow may be acceptable—although I wouldn’t consider this approach unless you have a sizeable portfolio and other cash-flowing properties to make up the gap.

Furthermore, be careful with this. Entrepreneurs are imbibed with a bias toward optimism. Merely hoping the property will appreciate is insufficient. There needs to be a really good reason to believe it will soon appreciate—and by a large margin.

Related: Stop! Before You Refinance, Consider These Tax Traps & Opportunities

3) Should You Sell?

Right now, the real estate market is in significant turmoil. It’s hard to tell if prices have dropped much, but sales certainly have.

Therefore, prices are likely to follow.

In this instance, it makes sense to hold off until the coronavirus lockdown is over to list a property. But that being said, don’t get too cute with trying to “time the market.” This is often just a euphemism for procrastination.

Furthermore, if you have a house that cash flows just barely while rented but won’t cash flow overall, I would usually wait until it becomes vacant before selling. That’s especially true if the property is nice enough it would attract homeowners and not just investors.

Conclusion

Negative cash flow sucks. I can’t tell you what to do in a broad sense—there are so many possible situations.

That being said, the key thing is to ignore your emotions and look at all of your options. Figure out the best path forward in a logical sense.

There are many things to consider, but do make sure you consider them all before jumping to a conclusion.

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Are you questioning the cash flow potential of a property you currently own? Why? What action do you plan to take?

Share below!

Andrew Syrios has been investing in real estate for over a decade and is a partner with Stewardship Investments, LLC along with his brother Phillip ...
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    Larry Russell Rental Property Investor from Whitsett, NC
    Replied 5 months ago
    Thank you for a timely article with some good insights.. I'm currently trying to figure out my next move with a vacant rental property. Either sell it as-is and hopefully break-even or invest more capital to add another bedroom and flip it for a small profit.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 5 months ago
    Now is probably not the best time to sell, at least in my opinion. Is renting it out again an option you would consider or is that off the table for other reasons?
    Jared Lambrecht
    Replied 5 months ago
    How long is too long to hold onto a property that is not cash flowing? I got into my duplex last year as a house hack with very low money down, and now have moved out. I have both sides rented, but don’t see my cash flow going positive for another 5ish years. I have the income to support this property and don’t really want to sell because it would take me out of the game. On the plus side, the property got me $2000~ back on my income taxes because of the losses I took.
    Lewis Christman Financial Advisor from Macungie, PA
    Replied 4 months ago
    The other way to potentially look at it is to compare it to your 401K contribution. Would I pay 100 a month to own a 100,000 property in 30 years? Assuming that is the maximum out of pocket each month for the whole time you contributed 36,000 for 100,000 property and then it would definitely cash flow. That being said you want it to cash flow NOW and take into account all the points above. I'm assuming you want to keep it and the cash flow issue is only temporary. My other point is even when you house hack to also look at the property from a pure investment and understand this issue up front prior to buying. The low down payment is good to get into a property yet bites in the back side when it comes to renting potentially.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 5 months ago
    It's really hard to say exactly, but I would probably slate this one to sell unless you think you can get the income up or really believe the area will appreciate soon. The market is very tepid right now, so I would probably wait a little to see how things go, but from afar, I would say it would make sense to sell relatively soon.
    Jay Dang Contractor from 92843, CA - California
    Replied 5 months ago
    I'm looking at things down your same path Jared. I'm thinking of my worst case scenario that I will not cash flow but at very least get the tax benefits on the back end every year. Thnks for sharing
    Jerome Kaidor Investor from Hayward, California
    Replied 5 months ago
    I bought a 20 unit building - in a bad neighborhood - at the top of the market in 2006. Let's call it the "Turkey". The Turkey ate my lunch to the tune of $3 to $5K per month neg for 10 years. The moment that the market recovered to the point that I could sell it and pay off the loan, I did so. Danced a jig when it was gone. It wasn't all bad.... to buy the Turkey, I had refinanced another complex. Loans were very competitive in 2006, and I was able to get a good one. When the poop hit the fan in 2008, the loan on the old complex went way down. In fact, I was saving just about as much in interest on that complex as I was losing on the Turkey. I sold the Turkey for about $400K less than I had paid for it. Sometimes, you just have to cut your losses.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 5 months ago
    Every investor I know has a story like that, some worse, some better. Those things suck the life out of you. Glad you were able to eventually get rid of it and save money on the refinance on the other complex to cover the bleeding.
    Austin Works Flipper/Rehabber from West Monroe, LA
    Replied 5 months ago
    I purchased a property in a package that overall cash flows, but this particular property wouldn't after factoring the needed repairs (house had been vandalized, needed wiring, HVAC and roof. I had to buy this one to get the other ones, but overall a great deal. For this dud property, I am selling vie owner finance so that I have no maintenance expense and received a sizable down payment. WIth maintenance and property managment out of the equation, this house will cash flow as long as this buyer remains.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 5 months ago
    We've done that before (buying a package and selling off one or two duds). Good strategy
    Kevin Leonce Investor from Atlanta
    Replied 5 months ago
    I appreciate your insight around this topic. This brings more clarity in analysing the situation and leads to a better more informed decision. Good job!
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 5 months ago
    Thanks Kevin, I'm glad you found it helpful!
    Mark Stedman Investor from Nashua, NH
    Replied 5 months ago
    Good article. But in my humble opinion, being 59 years of age and having considerable life experience, I see way too many younger people leveraging way too much. Borrowing can make you a fortune if you’re lucky, but it can also do you in very quickly of things go south. I only have 17 units. But I have zero debt and so I can net $9-10k per month. Sure I could ( and have been advised to ) take mortgages on my properties and go out and buy more, with the hope of increasing my “cash on cash” returns. But in times like these (meaning 2020-2021) I’m glad I’m where I’m where I am with no debt, except some on my own residence. I suspect we won’t be reading many more articles about the magic of BRRR for at least the next year or two.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 5 months ago
    The zero debt strategy is a good strategy. It's conservative and slower, but the low risk is a great way to go. I too am concerned about the amount of overleveraging going on which is why I always try to stress the importance of cash reserves, buying with equity, getting strong cash flow and not getting overleveraged, especially if you're using the BRRRR model. But I definitely respect the "no debt" strategy as well.
    Shankar Ramani
    Replied 5 months ago
    I'm a part-time investor with several properties. My strategy will likely not work for full-time real estate investors, but cash flow is not my first criteria. I choose pristine locations and school districts as my first criteria and on that criteria the cash flow is very small and sometimes none. However, this strategy has paid off well for me because the properties are so much sought after that I manage to rent these properties out in a matter of days with a lot of people queueing up. I also don't use property management services because I like doing the work. The rent for each of them goes up quickly and so does the property value. Given that these are high end school districts with relatively affluent people, I've had zero issues on rent payment due to the crisis - my tenants are always those with good credit and savings along with good income. Given so many choices for who I can have as tenant, I ensure I pick those with long tenure of jobs and in industries not likely to be impacted by recession. All things put together, such a model will likely make as good money and returns over the long term to replace the cash flow deficit. I'm also thinking that when inflation or hyperinflation occurs, properties with greater equity in them will survive better - when the cash that comes in as rental income itself is getting devalued, unless that income is reinvested back into real estate or gold or stocks, it probably needs to be discounted somewhat. Anyways, this won't work for full time investors, but may be worth considering as a certain percentage of everyone's portfolio going forward as we head towards uncertain times. The strategy could be to deliberately look for lower cash flow and more defensive properties that withstand broader economic shocks. We may have gotten too obsessive on using cash flow as a singular metric for real estate investing. The questions to ask now about such a strategy is - what is the quality of that cash flow - is it from a guaranteed / stable source of income? What is the percentage fluctuation of that cash flow when economic shocks occur? Will the percentage of lost rent when it is utilized low or high due to the attractiveness of renting it out? What happens when I sit with a lot of cash but that cash itself is becoming less valuable due to high inflation? And is my cash flow obsession violating the 1st rule of real estate - location, location, location?
    Tichard Niemi
    Replied 4 months ago
    Remember to figure gained equity from the principle reduction within the mortgage payment. Sometimes. $100 loss could actually be a $200 gain!
    Joe Scaparra Investor from Austin, TX
    Replied 4 months ago
    Great article with excellent recommendations! Getting control of our emotions is our biggest challenges. A couple comments from some of the feedback. Usually a no debt strategy evolved over time. Probably was borne out of debt and with the profits of the combined portfolio the properties mortgages were accelerated. I know for my 19 units, I had 5 mortgages at one time. Now at age 64, I have no need to acquire more properties and I used the profits to pay down debt, so yes I too am now debt free, but only because I reached my cash flow goal and have no desire to acquire more properties. Lastly someone mentioned the number one rule to real estate is Location, Location, Location. Sounds good, but I disagree from an investment standpoint. Sure on your personal residence, absolutely! Why live in a neighbored you don't like. However, my real estate investments focus on maximizing sustainable and predicable cash flow to enable me to retire with a high standard of living. I do this through investing in duplexes. Usually that involves lower income neighborhoods, ones that I would not live in now. People who rent duplexes usually are looking for a clean safe property. School choice is usually never a consideration as they are paycheck to paycheck and affordability is paramount. I do keep my duplexes upgraded and are probably the best property in an otherwise low income renters neighborhood. I also benefit by owning in a city that has an extreme shortage of affordable housing. Cheers.