Negative Cashflow, Appreciation for First rental property?

San Jose, California
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Negative Cashflow, Appreciation for First rental property?

Alex P.
Member since 2023 · 1 post · 0 votes

I'm a first-time home buyer looking to purchase my first rental property. I'm wondering whether negative cashflow for appreciation is a bad move for someone starting out.

I have a strong interest in buying in Folsom, CA. Its much cheaper for newer homes than the bay area, schools are all 9+/10, city has very high ratings for safety and quality of living, and the area looks to have a lot of growth in the next few years.

Only thing is negative cash flow. I can only put down up to 10%, so total monthly (with pmi, taxes, interest etc) will be around $4k-5k. Avg rent per room in the area is $900-1200, and avg rent per house is $3.2-3.6k. I plan to hold longterm and rent by room MTR/LTR, but assuming vacancies and at least 2 rooms occupied, I'll be short $2k-3k most months until rents follow the upward trend of home prices in the area or my monthly decreases.

I understand the huge emphasis on the cashflow-focused approach on BP, and that following appreciation is a gamble. However, if you're from/familiar with Norcal/sac, I'd like your advice on this move and projections for the city. I have a decently comfortable salary, so although it'll slow the rate at which I can save for the downpayment of another property, I can manage covering the negative cashflow. Also, despite all the new developments in the area, properties are selling like wildfire (in the case of TM, even before the models are built) and the number of available homes at this lower price range are becoming scarce. So, I'd like to make a decision before it's too late, or more buyers come into the market and increase competition.

Property Info: 550-600k, 3-4 rooms, loft (can later turn into an additional 4th/5th room to add value), 1800-2200 sqft, 2 car garage, hoping for a lot size suitable for an ADU/DADU

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Nathan GesnerBusiness Member
Moderator
Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes
3y
Quote from @Alex P.:

Welcome to the BiggerPockets forums!

Let's look at the numbers first. Let's say rent income is $4,000 a month. Your mortgage payment, taxes, and insurance is $4,000 a month. That's a break-even deal, right? Wrong! If the property sits vacant for a month, you lose $4,000. If a tenant trashes the carpet, you lose $10,000 for flooring plus $4,000 for the month, plus another $200 for utilities. These are common examples that happen all the time to every Landlord. When I calculate for cash flow, I include setting aside a 30% - 50% of the monthly rent to cover maintenance, vacancies, capital expenditures, taxes, insurance, and other projected costs, then I pay the mortgage and interest, then whatever is left over is considered cash flow. Your calculation doesn't account for other expenses. Even at a $400 loss per month, you would lose nearly $5,000 a year or $25,000 in five years and that's before dealing with any vacancies, maintenance, bad tenants, and other common expenses.

The other issue is betting on appreciation. Yes, property values will always go up over the long term. No, that doesn't mean they will go up over the next five years. The market had an historic rise for two years and peaked a year ago. Most housing and economic experts still believe we are facing a reckoning for all the "free" COVID money that was passed our for three years. The fact that buyers are still aggressively buying should be a warning that the correction has not happened yet. How would you feel if you bought this property with a monthly loss of $400 and then the market value dropped 10% next year? It could take you 5+ years just to break even. That's a gamble, not an investment.

Here's a guide that describes what good cash flow looks like and how to analyze a property.

https://www.biggerpockets.com/...

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  • Rick Albert
    Real Estate Agent · Los Angeles, CA · Member since 2018 · 2k+ posts · 1k+ votes
    3y

    The concern with negative cash flow is it hinders the ability to scale. For every repair or vacancy out of pocket, that sets you further back.

    You have to qualify for the mortgage and every mortgage after that (assuming you go conventional versus DSCR, etc.). Lenders will consider 75% of the rents towards your debt to income ratio.

    Personally, I try not to bank on appreciation because markets fluctuate. It is likely to go up on average over the next 30 years, but no one can say by how much. It's been a minute since I've been up to Folsom (I lived in Roseville for a few years), but I would imagine it would do well as people get priced out.

    Why not house hack in San Jose? I would rather lose money on a house hack since I'm living there anyways and it is better than renting.

    1Reply
  • Dave Skow
    Lender · Seattle, WA · Member since 2014 · 2k+ posts · 899 votes
    3y

    @Alex P.- thanks ...if buying it as a rental purchase and its a SFR - your down payment will likely need to be 15% or more ...if property is 2-4 unit - the down will need to be 25% or more of the purchase price ....10% down is unlikely or if hyou locate these terms - the pricing for the loan will liekly be very high ...if you can easily afford any negative rents for a long time - then not a bad idea ...but as some of the replies already point out - the actual neg rents can often be much larger than you expect or anticipate .....good first step is to get formally pre approved for the hypotehtical scenario you are estimating

    0Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    3y
    Quote from @Vadim F.:
    Quote from @Carlos Ptriawan:
    Quote from @Kevin McGuire:
    Perhaps a better word would have been "speculating" (versus investing).

    I think of real estate investing in terms of creating a business. Let's say I came to you and said, "Hey Alex, I have an opportunity for you: I'd like you to invest your money into a business that's losing money every year, with a single asset (thus ultra low diversification), and where I'm banking on appreciation over an unknown time scale because 'values always go up'?". How appealing an opportunity does that sound?

    For me the answer is "no thanks" because that sounds like speculation and I'm not a speculator.

    A few things to consider:

    1: You need cashflow to sustain an investment over the long term. Without it, you put your personal finances at risk. As with all investing, you need enough buffer to avoid being forced to sell in a down market. Cashflow gives you that. Worst scenario is that in an economic downturn you could lose your job, rents could drop, and home values could drop. Would you be able to hold on?

    2: Mortgage = leverage and that alone creates risk. So now you have two sources or risk. How will you mitigate them?

    3: I'm not sure if you've factored in costs for vacancy and repairs. Again, having some cashflow, and building up reserves, provides you resiliency to withstand short term financial problems.

    Now of course some people get rich speculating, but more lose money. You'd need to be clear on your risk tolerance and financial ability to withstand loses. Without knowing you, my advice would be to pass

     Speculating is when one do not see the trend. Buying appreciation is simply trend follower. 

    It really doesn't make different actually making +500/mo from cash flow property in 100k Alabama property compare to +40/mo from cash flow property in 1 mil property out of california. The HVAC cost itself is actually higher in cash flow property in Alabama, CA doesn't require HVAC LOL.

    I know from speaking of actual real life experience because I do both type of investment.

    All you mentioned above is called risk management, which is good. One should not do is doing all these cash flow thing without proper risk management. At the end of that day after capital gain, the net profit from appreciation city always wins.

    If one net worth liquid account is only 100k and doing -200 CF in bay area , yes that's crazy LOL

    @Carlos Ptriawan I’m curious to know what parts of the Bay Area you are investing in. Have you acquired any new investment properties in the last 6mo where you are cash flow negative but have 10% appreciation since you purchased it to now how to worry about cash flowing? Especially if you are negative 3+k a month.


    Hi Fadim, I have few houses in San Jose, Pleasanton and Hayward now. I was having in Antioch as well before I sold it. I still purchased last month in Hayward, it has ADU and basement so I'm all positive cash flowing. When I purchased, I make sure I'm DSCR 1.1 so down could be 30%.

    Please note the 10% appreciation occured from Feb 22 to March 23 and this is true for all county/city except San Jose. San Jose only appreciated 2%.

    If you go to local REI meeting there's bunch of people that's not just buying with negative cash flow, but few hedge fund/private equity fund basically hoarding houses LOL and sell it aftre 8 months LOL, they're even crazier.

    This particular market can't be compared with cash flow market somewhere in Indiana or Ohio. 
    Go visit open houses.

    0Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    3y
    Quote from @Rick Albert:

    The concern with negative cash flow is it hinders the ability to scale. For every repair or vacancy out of pocket, that sets you further back.

    You have to qualify for the mortgage and every mortgage after that (assuming you go conventional versus DSCR, etc.). Lenders will consider 75% of the rents towards your debt to income ratio.

    Personally, I try not to bank on appreciation because markets fluctuate. It is likely to go up on average over the next 30 years, but no one can say by how much. It's been a minute since I've been up to Folsom (I lived in Roseville for a few years), but I would imagine it would do well as people get priced out.

    Why not house hack in San Jose? I would rather lose money on a house hack since I'm living there anyways and it is better than renting.


     2023 is the BEST year in my view to purchase house for appreciation because the interest rate shape is going down as inflation moving down. Buyers are created from lower interest rate. In 2025/2026 it's 99% guaranteed rate would be lower. By 2027 everyone forgot that in 2022/2023 there's economic recession. Buying during downturn is the best always (really love when I purchased in 2009-2012 era). 

    The only question remaining is buying where ? it seems all market in bay area, milwaukee, birmingham , even Cody Wyoming, everywhere is all going up due to inflation hedge factor and supply/demand issue.

    I literally wait for this market to sell over-appreciated asset and buy under-appreciating asset (by means of BRRR).

    1Reply
  • Ranjit Sandhu
    Real Estate Broker · Rocklin, CA · Member since 2020 · 221 posts · 82 votes
    3y


    @Alex P. Folsom is a nice area and expensive compare to Roseville/Rocklin. The schools are in Rocklin are very comparable to Folsom can be better even, and the house prices are $50k lower than Folsom. Think about other areas if you are just buying to rent. You can buy 2-3 homes here the price of Bay Area homes...lol. Let me know if I can be any assistance.

    0Reply
  • Allan C.
    Rental Property Investor · Member since 2018 · 826 posts · 810 votes
    3y

    @Alex Pura my general guidance is if you're asking this question then you should not invest for appreciation until you are better capitalized and more experienced. You'll should be a sophisticated investor if you are using appreciation as a value driver. In the meantime learn the basics of REI through assets that can give you cash flow.

    When you have a sound understanding of IRR, NPV and discount rate is when you'll know whether investing in appreciation is right for you or not.

    1Reply
  • Account Closed
    Columbus, OH · Member since 2023 · 427 posts · 254 votes
    3y

    Sounds like a great property! Unfortunately, if your CFs are negative from day1, this is a massive risk. For one, you're banking a large investment on appreciation, which varies. Also, every incident, repair, damage, etc. will only further that negative CF, where a positive CF property would be able to "repair itself" through the profits. 

    0Reply
  • Vadim F.
    Investor · Member since 2020 · 337 posts · 213 votes
    3y
    Quote from @Carlos Ptriawan:
    Quote from @Vadim F.:
    Quote from @Carlos Ptriawan:
    Quote from @Kevin McGuire:
    Perhaps a better word would have been "speculating" (versus investing).

    I think of real estate investing in terms of creating a business. Let's say I came to you and said, "Hey Alex, I have an opportunity for you: I'd like you to invest your money into a business that's losing money every year, with a single asset (thus ultra low diversification), and where I'm banking on appreciation over an unknown time scale because 'values always go up'?". How appealing an opportunity does that sound?

    For me the answer is "no thanks" because that sounds like speculation and I'm not a speculator.

    A few things to consider:

    1: You need cashflow to sustain an investment over the long term. Without it, you put your personal finances at risk. As with all investing, you need enough buffer to avoid being forced to sell in a down market. Cashflow gives you that. Worst scenario is that in an economic downturn you could lose your job, rents could drop, and home values could drop. Would you be able to hold on?

    2: Mortgage = leverage and that alone creates risk. So now you have two sources or risk. How will you mitigate them?

    3: I'm not sure if you've factored in costs for vacancy and repairs. Again, having some cashflow, and building up reserves, provides you resiliency to withstand short term financial problems.

    Now of course some people get rich speculating, but more lose money. You'd need to be clear on your risk tolerance and financial ability to withstand loses. Without knowing you, my advice would be to pass

     Speculating is when one do not see the trend. Buying appreciation is simply trend follower. 

    It really doesn't make different actually making +500/mo from cash flow property in 100k Alabama property compare to +40/mo from cash flow property in 1 mil property out of california. The HVAC cost itself is actually higher in cash flow property in Alabama, CA doesn't require HVAC LOL.

    I know from speaking of actual real life experience because I do both type of investment.

    All you mentioned above is called risk management, which is good. One should not do is doing all these cash flow thing without proper risk management. At the end of that day after capital gain, the net profit from appreciation city always wins.

    If one net worth liquid account is only 100k and doing -200 CF in bay area , yes that's crazy LOL

    @Carlos Ptriawan I’m curious to know what parts of the Bay Area you are investing in. Have you acquired any new investment properties in the last 6mo where you are cash flow negative but have 10% appreciation since you purchased it to now how to worry about cash flowing? Especially if you are negative 3+k a month.


    Hi Fadim, I have few houses in San Jose, Pleasanton and Hayward now. I was having in Antioch as well before I sold it. I still purchased last month in Hayward, it has ADU and basement so I'm all positive cash flowing. When I purchased, I make sure I'm DSCR 1.1 so down could be 30%.

    Please note the 10% appreciation occured from Feb 22 to March 23 and this is true for all county/city except San Jose. San Jose only appreciated 2%.

    If you go to local REI meeting there's bunch of people that's not just buying with negative cash flow, but few hedge fund/private equity fund basically hoarding houses LOL and sell it aftre 8 months LOL, they're even crazier.

    This particular market can't be compared with cash flow market somewhere in Indiana or Ohio. 
    Go visit open houses.

     @Carlos Ptriawan so I live in Concord, bought my home in 2020, it appreciated 25% in 6mo after purchase. In March of 2022, an identical house like mines sold for $875k in same sub division. Last weekend, an identical home went on the market with the biggest yard in the sub division went on market for $800k. So is appreciation really 10% all around?  I see it as a decrease of 10% at current ask, it's currently pending so we will see how much it sells for to see the real appreciation.

    0Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    3y
    Quote from @Vadim F.:
    Quote from @Carlos Ptriawan:
    Quote from @Vadim F.:
    Quote from @Carlos Ptriawan:
    Quote from @Kevin McGuire:
    Perhaps a better word would have been "speculating" (versus investing).

    I think of real estate investing in terms of creating a business. Let's say I came to you and said, "Hey Alex, I have an opportunity for you: I'd like you to invest your money into a business that's losing money every year, with a single asset (thus ultra low diversification), and where I'm banking on appreciation over an unknown time scale because 'values always go up'?". How appealing an opportunity does that sound?

    For me the answer is "no thanks" because that sounds like speculation and I'm not a speculator.

    A few things to consider:

    1: You need cashflow to sustain an investment over the long term. Without it, you put your personal finances at risk. As with all investing, you need enough buffer to avoid being forced to sell in a down market. Cashflow gives you that. Worst scenario is that in an economic downturn you could lose your job, rents could drop, and home values could drop. Would you be able to hold on?

    2: Mortgage = leverage and that alone creates risk. So now you have two sources or risk. How will you mitigate them?

    3: I'm not sure if you've factored in costs for vacancy and repairs. Again, having some cashflow, and building up reserves, provides you resiliency to withstand short term financial problems.

    Now of course some people get rich speculating, but more lose money. You'd need to be clear on your risk tolerance and financial ability to withstand loses. Without knowing you, my advice would be to pass

     Speculating is when one do not see the trend. Buying appreciation is simply trend follower. 

    It really doesn't make different actually making +500/mo from cash flow property in 100k Alabama property compare to +40/mo from cash flow property in 1 mil property out of california. The HVAC cost itself is actually higher in cash flow property in Alabama, CA doesn't require HVAC LOL.

    I know from speaking of actual real life experience because I do both type of investment.

    All you mentioned above is called risk management, which is good. One should not do is doing all these cash flow thing without proper risk management. At the end of that day after capital gain, the net profit from appreciation city always wins.

    If one net worth liquid account is only 100k and doing -200 CF in bay area , yes that's crazy LOL

    @Carlos Ptriawan I’m curious to know what parts of the Bay Area you are investing in. Have you acquired any new investment properties in the last 6mo where you are cash flow negative but have 10% appreciation since you purchased it to now how to worry about cash flowing? Especially if you are negative 3+k a month.


    Hi Fadim, I have few houses in San Jose, Pleasanton and Hayward now. I was having in Antioch as well before I sold it. I still purchased last month in Hayward, it has ADU and basement so I'm all positive cash flowing. When I purchased, I make sure I'm DSCR 1.1 so down could be 30%.

    Please note the 10% appreciation occured from Feb 22 to March 23 and this is true for all county/city except San Jose. San Jose only appreciated 2%.

    If you go to local REI meeting there's bunch of people that's not just buying with negative cash flow, but few hedge fund/private equity fund basically hoarding houses LOL and sell it aftre 8 months LOL, they're even crazier.

    This particular market can't be compared with cash flow market somewhere in Indiana or Ohio. 
    Go visit open houses.

     @Carlos Ptriawan so I live in Concord, bought my home in 2020, it appreciated 25% in 6mo after purchase. In March of 2022, an identical house like mines sold for $875k in same sub division. Last weekend, an identical home went on the market with the biggest yard in the sub division went on market for $800k. So is appreciation really 10% all around?  I see it as a decrease of 10% at current ask, it's currently pending so we will see how much it sells for to see the real appreciation.


     No,

    Average appreciation long term per 10 year basis is only 5.7 to 5.85%.

    actual inflation is 3%.


    now if inflation is sticky at 4-5%, expect 4 percent at worst case, still better than 7% CD.

    0Reply
  • Jonathan R McLaughlin
    Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes
    3y

    So lots (and I do mean lots) of cash flow vs. appreciation debates on here and u can read some intelligent arguments for both.

    In this case we can skip all that back and forth. This is a bad deal under either approach. Projected negative cash flow at 2-3K???? So you lose 36k a year. That’s 8% of your purchase price.Even a boom in appreciation is going to be hard pressed to counter that. 

    Do not do this.

    3Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    3y
    Quote from @Jonathan R McLaughlin:

    So lots (and I do mean lots) of cash flow vs. appreciation debates on here and u can read some intelligent arguments for both.

    In this case we can skip all that back and forth. This is a bad deal under either approach. Projected negative cash flow at 2-3K???? So you lose 36k a year. That’s 8% of your purchase price.Even a boom in appreciation is going to be hard pressed to counter that. 

    Do not do this.


     Most newbie investor mistakes :
    - doesn't understand the very basic concept of cap rate, DSCR, price floor,etc
    - think appreciation is just random, something that's random gratifying on earth, think that the one that moves the price is the house itself and not market
    - inability to understand the market.

    There're just too many investors wanna invest here and there with minimum downpayment, simple math is showing with default cap rate of 3%, no investment could yield positive cash-flow if downpayment is only 10%. Some market here could only work downpayment as much as 40% just to reach actual DSCR 1.0 when all expenses are calculated.

    Second issue is the inability to gauge the market activity. Appreciation is not random. It's created based on complex intricacies between supply and demand, and supply and demand is inherently created by future interest rate (basically futures market) expectations. If interest rate slope is expected to go down, one would have more buyer pool, vice versa. But it's very true as well, even during high inflation, since default mortgage in US is 30 years fixed, this forces many people not to sell their homes (aka they trapped into their own low interest rate mortgage) thus not too many houses are being released into the market (for example: market supply in Feb 2023 is very different than market supply in 2022), this action itself causes very strange phenomena:

    where home price is going up during high interest rate, becoz, the supply has been limited so much that seller doesn't want to sell.

    1Reply
  • James Hamling
    Real Estate Broker · Minneapolis, MN · Member since 2011 · 5k+ posts · 6k+ votes
    3y
    Quote from @Alex P.:

    I'm a first-time home buyer looking to purchase my first rental property. I'm wondering whether negative cashflow for appreciation is a bad move for someone starting out.

    I have a strong interest in buying in Folsom, CA. Its much cheaper for newer homes than the bay area, schools are all 9+/10, city has very high ratings for safety and quality of living, and the area looks to have a lot of growth in the next few years.

    Only thing is negative cash flow. I can only put down up to 10%, so total monthly (with pmi, taxes, interest etc) will be around $4k-5k. Avg rent per room in the area is $900-1200, and avg rent per house is $3.2-3.6k. I plan to hold longterm and rent by room MTR/LTR, but assuming vacancies and at least 2 rooms occupied, I'll be short $2k-3k most months until rents follow the upward trend of home prices in the area or my monthly decreases.

    I understand the huge emphasis on the cashflow-focused approach on BP, and that following appreciation is a gamble. However, if you're from/familiar with Norcal/sac, I'd like your advice on this move and projections for the city. I have a decently comfortable salary, so although it'll slow the rate at which I can save for the downpayment of another property, I can manage covering the negative cashflow. Also, despite all the new developments in the area, properties are selling like wildfire (in the case of TM, even before the models are built) and the number of available homes at this lower price range are becoming scarce. So, I'd like to make a decision before it's too late, or more buyers come into the market and increase competition.

    Property Info: 550-600k, 3-4 rooms, loft (can later turn into an additional 4th/5th room to add value), 1800-2200 sqft, 2 car garage, hoping for a lot size suitable for an ADU/DADU

     Ok Alex, let me answer this by telling you what I am hearing from all this. 

    I am hearing that your dead set of ramming square peg's into round holes.... 

    Your heart is set on investing in a market that is NOT good for investing in. But you'll be damned if you do differently. Ok, then what's any info matter? You already know it's not wise, you detailed that, your just on here hoping someone is going to justify the foolish actions, and were not. 

    What your doing is NOT investing, and I think you know that. It's an ego-stroke. Investing follows the math, and does not argue with the math. Again, your trying to force square peg's in round holes. 

    Yes, APPRECIAITION is "THE" master-play BUT you have to actually have a market and asset of fact based appreciation expectations and you don't have it. What you have is called "buying-at-the-top" and "FOMO". Neither are "Investing", there EMOTIONAL actions, and in this business emotion get's you BROKE. 

    1Reply
  • Hamp Lee IIIPro Member
    Real Estate Agent · San Antonio, TX · Member since 2019 · 1k+ posts · 832 votes
    3y

    No.

    Remember, real estate investing is a numbers game, not an emotional one. Houses will come and go, but know a great house is out there for you, but not that one.

    Keep looking and wait for the numbers to work out. Don’t worry if the market is getting scarce. There are still deals out there…all you need to find is one.

    0Reply
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