Is Losing Money Normal In the Beginning?

[Ross Kline]

I've been analyzing deals for a couple weeks now. A mix of single-family, small multi-family, BRRRR, and even a 20-unit apartment.

I'm a numbers guy, so I've done my research and believe I am using accurate numbers when calculating NOI and cap rates.

What I've found is that on-market deals typically have a cap rate of 5% or less, and after debt service cash flow is often negative, especially at current loan rates.

So do investors just have the income and cash to buy and wait for spreads to widen as rents increase?

Would love to hear your thoughts!!

[Jerry Lucker]

One reply mentioned buying a mobile home in a park and renting it out. I can add a little to that. Most parks require the occupant to own the home. Buying a mobile home in a park can still be a great investment though. Because they're considered personal property, not real estate, they can offer investors some unique opportunities; the purchase prices are significantly lower than real estate investments, the profit margins can be much greater than most real estate deals, buying and selling is quick and easy (like a car), the comps/numbers are simple to figure accurately, most investors overlook mobile homes, you deal with the house only - not the land or infrastructure.

You just flip the mobile home. Because the occupants are leasing the land, they have to qualify to live in the park. They have to meet employment and credit standards as well as a background check. They can easily obtain financing so you can walk away with cash from the sale. Unlike renting, you don't have to worry about the rent every month, evictions, trashed units, maintenance, etc.

After more than two decades in the business, I now own a nice portfolio of income producing real estate - all of it purchased with the profits made from flipping mobile homes in parks :) 

[Sebastian Giraldo]

It is great that you are now at the point were you can distinguish a good deal from a bad deal. Good job on putting in the repetitions. 

For sophisticated, well-capitalized and experienced investors cashflow loosers are okay becuase they understand the long term pay-off will be worth it. With that in mind it is all about the exit strategy. 

For starters that are beginning to get a sense of real estate, tenants, repairs, contracts, etc it is not the brightest idea to start off with a risky, negative cashflow play. 

My advice to you @Ross Kline is to continue sifting through enough deals until you can identify the solid green positive cashflow investment after repairs and bringing rents to the market value. 

[Shivam Patel]

@Ross Kline

You can still fix this assuming the market rent is higher. It's possible whoever bought it previously never increased the rent at is stuck at 3100. Its hard for me to imagine with 5unit you can't reach 4k in rent. Where is the location? Have you used rentometer for br/ba to look at market rent. What are the rental comps? Additionally the comps could be higher but only for higher finishes. Not sure what the rehab looks like but it might be worth it to do updates to the property if the market calls for it just to push rents up. However you have to looks at the laws if they are existing tenants on changing rent prices. If it's a vacant unit it makes it easier post rehab. Depends on the comps though. If there all 2br 1ba, in my market goes for 1650 each unit.

Just a thought.

Sincerely,

[Michael K.]

@Ross Kline It would be a hard no for me with that kind of negative cash flow. Ensuring that you have positive cash flow on each of your deals is what's going to allow you to keep building your business. Otherwise, your properties are just going to drag you down. Remember that you will always be up against retail consumers, i.e. people who want a nice place to live, spend too much time on Zillow, and aren't thinking logically about prices. Keep your head up and you'll find a deal that pencils out, there are still plenty of markets where deals can turn a profit, just need to look harder (and more creatively) now.  

[Carlos Ptriawan]

Quote from @Mike Hern:

Quote from @Ross Kline:

 I love the line "I lose money on every deal but I'll make it up in volume".  Seems Opendoor, Offerpad, Redfin, Zillow all had that approach and now they are leaving the market with substantial losses and their tail (in this case spreadsheet) between their legs.

The first rule of investing: 1. Don't lose money, 

the second rule: 2. See rule 1 

 When Zillow, Opendoor , MF syndicators and Homebuilders are having difficulty making money in the current business climate, why do you want to force yourself to invest in a sector in which you do not even have experience ..

Rather than losing money, better put that money somewhere else.

[Jay Hinrichs]

Quote from @Carlos Ptriawan:

Quote from @Daniel Shuler:
This is something I've been seeing a lot of lately that leaves me scratching my head. Sometimes I feel like "Am I missing something here?". What I'm seeing are numerous multifamily properties, brand new, old, updated, not updated, that are listed that even after a 20% down payment, with today's interest rates, wouldn't even cover the mortgage, let alone all of the other things you may need to account for like CapEx, PM, etc.
How are these sellers/realtors coming up with their prices when the numbers don't seem to jive for an investor?

 because you use the 20% down - a 2009 environment number ; in year 2022. It's that simple.

the logic you guys using fo not calculating all the appreciation dynamics that happened since 2008-2009. 

cash buyers and 1031 buyers are still snapping up 5 to 5.5 caps..  

[Bob Stevens]

Quote from @Ross Kline:

I've been analyzing deals for a couple weeks now. A mix of single-family, small multi-family, BRRRR, and even a 20-unit apartment.

I'm a numbers guy, so I've done my research and believe I am using accurate numbers when calculating NOI and cap rates.

What I've found is that on-market deals typically have a cap rate of 5% or less, and after debt service cash flow is often negative, especially at current loan rates.

So do investors just have the income and cash to buy and wait for spreads to widen as rents increase?

Would love to hear your thoughts!!

 Heck no, 1st off all my deals are cash as are all my client.  All my personal properties have been and will always be 20%++ NET cap rates, maybe and exception here and there. Double digit net caps are to be had , its all about your team and knowledge

All the best 

[Luka Milicevic]

For hedge funds based in CA and NY it's probably normal. They buy at zero caps bc they have too much money to deploy.

If you're not a hedge fund....then probably just need to find a better deal. 

On market properties in the current environment are not going to be the best. 

[Carlos Ptriawan]

Quote from @Jay Hinrichs:

Quote from @Carlos Ptriawan:

Quote from @Daniel Shuler:
This is something I've been seeing a lot of lately that leaves me scratching my head. Sometimes I feel like "Am I missing something here?". What I'm seeing are numerous multifamily properties, brand new, old, updated, not updated, that are listed that even after a 20% down payment, with today's interest rates, wouldn't even cover the mortgage, let alone all of the other things you may need to account for like CapEx, PM, etc.
How are these sellers/realtors coming up with their prices when the numbers don't seem to jive for an investor?

 because you use the 20% down - a 2009 environment number ; in year 2022. It's that simple.

the logic you guys using fo not calculating all the appreciation dynamics that happened since 2008-2009. 

cash buyers and 1031 buyers are still snapping up 5 to 5.5 caps..  

yes but gone is reason to invest in US market when IRR is only 5-6% ; investing in Manila one could have IRR of 10-15% at least.

Even better investing at nasdaq now with cash could yield IRR of 20-30%.

[Dan Heuschele]

>Is Losing Money Normal In the Beginning

as is often the case i am the contrarian.  

I believe most newbie REI in my market are losing money at least in the short term. Just run the numbers on the duplexes, triplexes, and quads and it will show they are cash flow negative. I believe the majority of the buyers of these properties are less experienced RE investors.

the experienced investors are not buying properties with this level of negative cash flow. they often purchase off market properties (my last MLS purchase was in 2014). They often have more sophisticated value adds than a simple rehab as part of a BRRRR.

If you purchase an MLS listing, you typically are paying retail or, in hot markets, sometimes over retail. Experienced RE investors do not pay over retail and pay retail only if there is a value add that can provide additional return.

If the experienced RE investors are not purchasing the properties that are losing money, it implies that the less experienced RE investors *those in the beginning of their REI journey) are buying these properties and losing money (at least until rents increase enough that they are not cash flow negative or the RE has appreciated enough that the appreciation surpasses the cumulative negative cash flow).

Good luck

[Kar Sun]

My properties must cash flow (even if it is just $200) and appreciate. I did buy at retail but I negotiated deeply pre 2019. Yours is a no. 

[Bud Gaffney]

Never normalize losing $. 

[Bud Gaffney]

Losing $ is never normal.

[Crystal Smith]

Quote from @Ross Kline:

I've been analyzing deals for a couple weeks now. A mix of single-family, small multi-family, BRRRR, and even a 20-unit apartment.

I'm a numbers guy, so I've done my research and believe I am using accurate numbers when calculating NOI and cap rates.

What I've found is that on-market deals typically have a cap rate of 5% or less, and after debt service cash flow is often negative, especially at current loan rates.

So do investors just have the income and cash to buy and wait for spreads to widen as rents increase?

Would love to hear your thoughts!!

 To answer the question you posed for this thread "Is Loosing Money Normal In The Beginning".  The answer is yes if you are only looking at properties with relatively high cost and rents that aren't enough to cover the debt service and expenses.  Are those bad deals?  Not necessarily, especially if you're able to increase rents over time while reducing expenses. If a deal at the beginning is break even & it's located in an area where values have traditionally always increased & it's an attractive area where you can eventually increase rent then go for it.

[Carlos Ptriawan]

Quote from @Dan Heuschele:

>Is Losing Money Normal In the Beginning

If the experienced RE investors are not purchasing the properties that are losing money, it implies that the less experienced RE investors *those in the beginning of their REI journey) are buying these properties and losing money (at least until rents increase enough that they are not cash flow negative or the RE has appreciated enough that the appreciation surpasses the cumulative negative cash flow).

Good luck

For me, it has nothing to do with experienced/non-experienced. But of course, the experienced know the algorithm a bit better. 

For example, every city in USA has its own HIDDEN default cap rate (you could subscribe to Crexi intelligence to figure it out).

Now, those cap rate is moving lower every year due to appreciation (which is a good thing).

So the first variable that we know is that, we could only invest if cap rate is higher than X%, right. Lets say this number is 8%.
NOw that 8% cap rate, could only be achieved in this city of x1,x2,x3 ; with mortgage leverage ratio of 1:5 and sub 3% interest rate, in the year 2015 for example this calculation is still making sense.

But now since those cap rate is feeling more compression and compression, and crazy high mortgage rate, it's no longer making sense to invest in the old way. 

Even now we know the GP level syndication has a big problem as the cost of financing is so large it doesn't make sense to invest except with a cash position only like someone described above.


Another note: I kept thinking about whether there's a price ceiling in the real estate market, and after so much research on this, I found the answer is yes. A negative cap rate has existed for years in Asia now. Now in 2022, some zip code in the USA has experienced the same, the last time I checked, there are some zip code where the sold price in the last 5 months is gratifying with the price of 2017-2020 level. It seems in this area, there would be 0 appreciation for decades.

Which also means this area is the worst for investment as it has a negative yield.

[John Warren]

@Ross Kline the question is not whether you are buying a 5 cap or not. The question is, what is your business plan? Is this 5 cap in a C class area or is it an ocean front property? Can you renovate and push rents? Maybe the 5 cap makes sense. Here in Chicago, I normally see broker OM's having anywhere from a 5 to a 7 cap on there. These numbers are often times based on very low expense ratios too. This is normal marketing, and we have to learn how to read between the lines. 

I think there is a huge misconception about how important the cap rate when you buy is. Like a lot of buyers are assuming you can buy a 9 or 10 cap, put it with a property manager, and then go to move to a beach. Cap rate is more a function of risk versus how the cash flow will actually perform when you are looking at broker pro formas. 

[Dan Heuschele]

Quote from @Carlos Ptriawan:

Quote from @Dan Heuschele:

>Is Losing Money Normal In the Beginning

If the experienced RE investors are not purchasing the properties that are losing money, it implies that the less experienced RE investors *those in the beginning of their REI journey) are buying these properties and losing money (at least until rents increase enough that they are not cash flow negative or the RE has appreciated enough that the appreciation surpasses the cumulative negative cash flow).

Good luck

For me, it has nothing to do with experienced/non-experienced. But of course, the experienced know the algorithm a bit better. 

For example, every city in USA has its own HIDDEN default cap rate (you could subscribe to Crexi intelligence to figure it out).

Now, those cap rate is moving lower every year due to appreciation (which is a good thing).

So the first variable that we know is that, we could only invest if cap rate is higher than X%, right. Lets say this number is 8%.
NOw that 8% cap rate, could only be achieved in this city of x1,x2,x3 ; with mortgage leverage ratio of 1:5 and sub 3% interest rate, in the year 2015 for example this calculation is still making sense.

But now since those cap rate is feeling more compression and compression, and crazy high mortgage rate, it's no longer making sense to invest in the old way. 

Even now we know the GP level syndication has a big problem as the cost of financing is so large it doesn't make sense to invest except with a cash position only like someone described above.


Another note: I kept thinking about whether there's a price ceiling in the real estate market, and after so much research on this, I found the answer is yes. A negative cap rate has existed for years in Asia now. Now in 2022, some zip code in the USA has experienced the same, the last time I checked, there are some zip code where the sold price in the last 5 months is gratifying with the price of 2017-2020 level. It seems in this area, there would be 0 appreciation for decades.

Which also means this area is the worst for investment as it has a negative yield.

 Is it your belief that experienced syndicators are going to do poorly?   The syndicators that I invest in have sophisticated value adds (value adds in excess of simple rehab) and in recent years hit max GP profit share every time. These are experienced, sophisticated RE investors.  There are some syndicators that even in the Great Recession did not loose their LPs’ money (they did not provide decent return, but at least did not lose money).  Do not invest with a syndicator that is doing a significantly larger or different offering than any they have accomplished previously.  Do not invest with a syndicator that only has a few completed syndications.  In this market, there will likely be some syndications that lose LP money.

Similar, I have not found an MLS listed property with only a rehab as the value add that meets my expected profit expectation in a long time because there are people willing to accept smaller profits than I am or investors who are very aggressive (or uneducated) in their pro formas. These, for the most part, are not experienced RE investors (experienced RE investors have purchased a small percentage of their investments from the MLS in the last few years). These novice RE investors that are purchasing these investments off the MLS with thin profit margins (or often negative cash flow) have done well because in the recent times virtually every deal has done well due to property and rent appreciation. I suspect that there will not be significant property appreciation in most markets for the next couple of years.

Are you referring to a negative commercial residential cap rate?   What market do you believe has a negative cap rate and on what category of RE?  I guess I could see it as a possibility in low class (think war zone), declining population, commercial residential but i have not heard of it.

[Account Closed]

Follow @RentalRobert on TikTok.  He finds good deals and shares them!

[Carlos Ptriawan]

Quote from @Dan Heuschele:

Quote from @Carlos Ptriawan:

Quote from @Dan Heuschele:

>Is Losing Money Normal In the Beginning

If the experienced RE investors are not purchasing the properties that are losing money, it implies that the less experienced RE investors *those in the beginning of their REI journey) are buying these properties and losing money (at least until rents increase enough that they are not cash flow negative or the RE has appreciated enough that the appreciation surpasses the cumulative negative cash flow).

Good luck

For me, it has nothing to do with experienced/non-experienced. But of course, the experienced know the algorithm a bit better. 

For example, every city in USA has its own HIDDEN default cap rate (you could subscribe to Crexi intelligence to figure it out).

Now, those cap rate is moving lower every year due to appreciation (which is a good thing).

So the first variable that we know is that, we could only invest if cap rate is higher than X%, right. Lets say this number is 8%.
NOw that 8% cap rate, could only be achieved in this city of x1,x2,x3 ; with mortgage leverage ratio of 1:5 and sub 3% interest rate, in the year 2015 for example this calculation is still making sense.

But now since those cap rate is feeling more compression and compression, and crazy high mortgage rate, it's no longer making sense to invest in the old way. 

Even now we know the GP level syndication has a big problem as the cost of financing is so large it doesn't make sense to invest except with a cash position only like someone described above.


Another note: I kept thinking about whether there's a price ceiling in the real estate market, and after so much research on this, I found the answer is yes. A negative cap rate has existed for years in Asia now. Now in 2022, some zip code in the USA has experienced the same, the last time I checked, there are some zip code where the sold price in the last 5 months is gratifying with the price of 2017-2020 level. It seems in this area, there would be 0 appreciation for decades.

Which also means this area is the worst for investment as it has a negative yield.

 Is it your belief that experienced syndicators are going to do poorly?   The syndicators that I invest in have sophisticated value adds (value adds in excess of simple rehab) and in recent years hit max GP profit share every time. These are experienced, sophisticated RE investors.  There are some syndicators that even in the Great Recession did not loose their LPs’ money (they did not provide decent return, but at least did not lose money).  Do not invest with a syndicator that is doing a significantly larger or different offering than any they have accomplished previously.  Do not invest with a syndicator that only has a few completed syndications.  In this market, there will likely be some syndications that lose LP money.

Similar, I have not found an MLS listed property with only a rehab as the value add that meets my expected profit expectation in a long time because there are people willing to accept smaller profits than I am or investors who are very aggressive (or uneducated) in their pro formas. These, for the most part, are not experienced RE investors (experienced RE investors have purchased a small percentage of their investments from the MLS in the last few years). These novice RE investors that are purchasing these investments off the MLS with thin profit margins (or often negative cash flow) have done well because in the recent times virtually every deal has done well due to property and rent appreciation. I suspect that there will not be significant property appreciation in most markets for the next couple of years.

Are you referring to a negative commercial residential cap rate?   What market do you believe has a negative cap rate and on what category of RE?  I guess I could see it as a possibility in low class (think war zone), declining population, commercial residential but i have not heard of it.

Some of the current syndicators are losing money, some deals are selling 20% from projection.  

The negative cap rate is in residential also, in the highest appreciation area in the country. Price in the last 12 months never breaks any more new records, it's just gratifying between the last 4-year prices. The moral of the story is any investor should be extremely careful investing at current climate, as there's a possibility that we will have no growth in the next few years with declined rent growth and fantastic mortgage payment. Not saying we'll have price decline like in other thread but some CA market is showing stagnant appreciation now.

[Rebekah Meyer]

So glad to see a numbers person on here!  I have 12 years as a data analyst and I dabble as a data scientist.  I got into real estate investing building a rudimentary model and I followed the numbers, not the stigma, and ended up never investing in a house where the numbers did not make sense.  Now, I did make TERRIBLE mistakes with the contractors I hired and trusted, but, I had to learn and now I'm trying to never make those mistakes again.  Still, my numbers are what drives this business and at the end of the day, they will out-compete people going on gut feelings. 

Losing money when you first start out investing is unfortunately not uncommon.  I almost went bankrupt my first year investing due to contractor fraud and literally had to move into one of my flips and watch YouTube videos to finish it myself to generate enough money to finish the next project and so on.  But no one can lose money indefinitely.  You either learn and get into the black, even if its just a small amount of profit, or you will eventually run out of capital. 

In terms of bad rentals, I see those all the time!  I worked for a hedge fund that was regularly buying properties that have a .05% Rent/Mortgage.  This hedge fund is then going back to its fund investors and saying "Well, this return is just how it is in real estate."  It's unconscionable in my opinion!  If you would drive one city over from where I live, there are still plenty of 1% rule properties.  Yes, they are harder to find.  But every week I see properties at the sheriff sale where an investor did not do the math and brought a property that was in the negative from the beginning.

I now only keep properties that are 1% or even higher (yes, there are still higher ones too) on my books and flip the rest.  It's been grueling and I had to get out of my comfort zone and leave my desk and my computer models (yikes real world!!!), but now I'm in the trenches and its finally working.  Let the numbers lead!

[Nate Sanow]

What's on the market rarely makes sense for investors from an IMMEDIATE ROI perspective right now, unless, going after highly distressed property and willing to do some sort of value ad. It's oxymoronic as a realtor to say it I know but I'm lying if I say otherwise, and even with access to the mls I personally go off market. Off market, for me, usually can provide positive cash flow year one, and all the other good stuff year 2,3, etc (other good stuff being appreciation, depreciation, equity growth, principal reduction, tax mitigation etc).

[Robert Whitelaw]

Quote from @Daniel Shuler:
This is something I've been seeing a lot of lately that leaves me scratching my head. Sometimes I feel like "Am I missing something here?". What I'm seeing are numerous multifamily properties, brand new, old, updated, not updated, that are listed that even after a 20% down payment, with today's interest rates, wouldn't even cover the mortgage, let alone all of the other things you may need to account for like CapEx, PM, etc.
How are these sellers/realtors coming up with their prices when the numbers don't seem to jive for an investor?

This is a great point that I am seeing in my market as well. I do a pretty comprehensive analysis of properties and when it comes to multi-family units, it is all about the math. I am working with a sellers agent on a property I found last week and I simply sent them my breakdown. It simply does not pencil out as a good investment at the current price and the seller is still trying to stick to their price right now.

The agent suggested putting more down to make it flow, which then kicks ROI into levels that don't meet any reasonable minimum. I laid out both scenarios for them with data and I am waiting for a reply at the moment.

Of course, this is before even SEEING the inside of the units! They are not allowing any viewing until there is an accepted offer. I cannot recall the last time I did a deal like that where I did not come out insisting on concessions from the seller.

One issue I am seeing feeding this is real estate agents that are clueless about multi-family investing. They then set very poor expectations for their seller clients and if any creative solutions come up - it is deer in the headlights time for them.

On the upside, that all spells opportunity for the folks that are chasing the right deal - it just requires a greater investment of time on the negotiating side.

[Daniel Shuler]

Quote from @Robert Whitelaw:

Quote from @Daniel Shuler:
This is something I've been seeing a lot of lately that leaves me scratching my head. Sometimes I feel like "Am I missing something here?". What I'm seeing are numerous multifamily properties, brand new, old, updated, not updated, that are listed that even after a 20% down payment, with today's interest rates, wouldn't even cover the mortgage, let alone all of the other things you may need to account for like CapEx, PM, etc.
How are these sellers/realtors coming up with their prices when the numbers don't seem to jive for an investor?

This is a great point that I am seeing in my market as well. I do a pretty comprehensive analysis of properties and when it comes to multi-family units, it is all about the math. I am working with a sellers agent on a property I found last week and I simply sent them my breakdown. It simply does not pencil out as a good investment at the current price and the seller is still trying to stick to their price right now.

The agent suggested putting more down to make it flow, which then kicks ROI into levels that don't meet any reasonable minimum. I laid out both scenarios for them with data and I am waiting for a reply at the moment.

Of course, this is before even SEEING the inside of the units! They are not allowing any viewing until there is an accepted offer. I cannot recall the last time I did a deal like that where I did not come out insisting on concessions from the seller.

One issue I am seeing feeding this is real estate agents that are clueless about multi-family investing. They then set very poor expectations for their seller clients and if any creative solutions come up - it is deer in the headlights time for them.

On the upside, that all spells opportunity for the folks that are chasing the right deal - it just requires a greater investment of time on the negotiating side.

That’s great to hear and sounds like what I’m seeing around here. I haven’t put any offers in yet, but keeping my eye on them, and will clearly have to do as you have and make offers with data to support my offer.

[Robert Whitelaw]

To answer the original question tho - No - it is not normal to lose money on a deal. The point of the deal is for it to be positive cash flow for you.

If you are talking about multi-family deals, it should all be about the math. Unlike SFRs, there should be ZERO emotion involved. If someone is going on about the sentimental value of their duplex, that might be your que to move on.

Right now, the reality is that finding properties that flow with a decent ROI is tough. At least this is the case in my area. Its nearly impossible in the heart of Silicon Valley. However, as of this week, I am finding way more multi's coming on the market and just staying there in that market. I keep an eye on them and will usually reach out after 30 days to get a feel for how soft their asking price as become. But in some cases, the price would have to go down by several 100k for it to flow.

[Jon Frantz]

What are you trying to accomplish? What's your strategy for accomplishing it? What resources do you have available to you? What time frame are you trying to accomplish it in; what's your time horizon look like? I ask as these questions are fundamental to the types of risks you're willing to take.

You've suggested buying properties at a loss in today's market and waiting for them to appreciate. If you have large amounts of money, can afford to lose money until the market "corrects" in your favor and strongly believe in the hypothesis that the market will "correct" in your favor, then what you've suggested may work for you. If none of those things is true given your answers to my initial questions, then it would seem that plan isn't for you. 

Here's an interesting question: Assuming the data you've been using to analyze properties is publicly available and let's say you had found one or two properties that meet your metrics, would you be happy and excited to invest in them? I believe most new investors would be. 

However, there's an issue here. Unless you're using some proprietary formulas that no one else has heard of, every other investor in your region can see the same 1-2 deals that you've found. Why haven't they invested in them? You may discover by asking this question that you're the luckiest person in the world; you spent a couple of weeks looking, found a couple of properties that cashflow positively and are on the road to long term wealth. OR maybe there's a reason no other investor has purchased those properties. Which do you think is more likely? 

If you assume the market is weakly efficient, then theoretically it should be impossible to "find money" given publicly available data. In practice, I think most would argue that the market isn't efficient due to the existence of information asymmetries. If you're more informed about a particular neighborhood or niche within the market or you have better access to information than the next person, you can leverage that advantage into a positive return. This is why, "becoming a market expert" and, "build your network" are always suggested. The only other option is to be a contrarian, buy when everyone sells and sell when everyone buys.