Is a negative cash flow property NOT an asset?

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Is a negative cash flow property NOT an asset?

Maxwell Milholland
Buffalo, NY · Member since 2018 · 86 posts · 30 votes
Hello Bigger Pockets community! I've read enough books at this point to have a pretty basic grasp on the fundamentals of real estate. One principle that comes up time and time again is cash flow. There seems to be a consensus that a positive cash flow is what an investor should strive for, and a negative cash flow is bad. I'd like to hear your opinion on this matter. I think that this is perhaps too black and white. Take for example a duplex that cash flows 200 a month. Decent investment right? It's certainly better than one that has a negative 200 cash flow. But is the negative cash flow property BAD? I don't think it is. The only difference between the two is 400 dollars a month. 4800 a year. Sure, that's a good amount of money. But, the reason why the positive cash flow property is an asset, at least in my mind, is due to more than just the income it produces. Tax benefits, loan paydown, and potential appreciation all are factors that make this a valuable asset. These same factors also make the negative cash flow property an asset, just one that doesn't pay for itself. I don't think that's bad, so long as you have prepared for that and have other income to offset that. Essentially, I see it as paying a monthly fee for an asset that will make you far more money in the long run than what you pay for it monthly. Again, a positive cash flow property is better, but I think a negative one CAN be okay. What do you think? I'm open to being completely wrong here.
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Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
8y

The cost of any hold property, is what comes out of your pocket...that's it.  

If you buy a property for 100k, put 20% down, and have positive cash flow, that property cost your $20k.  If that same property had a negative cash flow of $100/month (1200/y), that property cost you $21,200 after year 1, $22,400 after yr 1, $23,600 after 3, and so on...until you fix the cash flow.  Then, you have to generate positive cash flow equal to your total cost before you can make a profit.

The goal in REI is not to own, but to control RE. Another way to look at this is what comes out of your pocket is what your cost is to control a property. Once you recover your "cost to control", you are making a profit from that point forward (as long as you keep the positive CF), and now it cost you nothing to control it.

Who pays the rest of the sale price?  As long as you have positive CF...the tenant(s) do.  That's their job.

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  • Bjorn AhlbladPro Member
    Investor · Shelton, WA · Member since 2017 · 6k+ posts · 6k+ votes
    8y

    A negative CF property is a lability even if you are replacing a worse dog in a 1031x. And forget appreciation.............that does not happen till you sell-maybe not then either. I know people who lost their shorts with property in California’s Silicon Valley. All you have to do is buy at the wrong time and be forced to sell and guess what? If it does not CF really well it is not for me.

    1Reply
  • Andrew SyriosPro Member
    Moderator
    Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes
    8y

    Depends on how you define asset. Technically yes. But in most cases, it's not a good asset to hold.

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    0Reply
  • Account Closed
    Austin, TX · Member since 2013 · 54 posts · 14 votes
    8y
    If youre In an apprecIatIng market and have job that you don’t hate, (so you don’t depend on the cash flow from the property) then a negative cash flow can also be an asset in the long term. You can also pay down your loans more aggressively and be negative or near 0 cash flow while building wealth for long term. Hope this helps
    0Reply
  • Mace Smallwood
    Piscataway, NJ · Member since 2018 · 5 posts · 3 votes
    8y
    @Maxwell Milholland Go to"the book on real estate rental investing" chapter 7. Should give you much insight. The blue book by Brandon Turner.
    0Reply
  • Luka Milicevic
    Real Estate Agent · Nashville, TN · Member since 2015 · 2k+ posts · 2k+ votes
    8y

    Only answer I can give is it depends.

    I currently have 3 negative cash flowing properties. They are all on 15 year notes.

    The only reason I would accept a negative cash flowing property in the case of my 3 is for 2 reasons:

    1-I have nothing in the deal

    2-I don't intend on keeping them as long term rentals

    My negative cash flowing rentals are all on lots that are zoned for two houses. As soon as I get to them, I'm going to tear down the existing house and build two brand new homes that I'm going to sell.

    I will never buy a negative cash flowing rental with the hopes of holding it long term. When I buy a true long term rental, my goal is to keep it for quite literally forever-and if that's the case then I can't afford -200/month. 

    1Reply
  • Garrett Ellison
    Baton Rouge, LA · Member since 2018 · 39 posts · 28 votes
    8y
    Originally posted by @Frank Jiang:

    Cashflow is a garbage metric.

    The same house can have positive or negative cashflow depending on whether you put 0%, 5%, 25% or 100% down.

    Most people don't even calculate cashflow properly and fail to account for deferred maintenance or future capex spend.

    It "works" fine for simple deals, but any investor worth their salt is capable of underwriting to IRR.

     Hot take.  Although, @Brandon Turner often says it's a numbers game. What you said it absolutely correct, just play around with the numbers until it cash flows and ROIs where you like it. I do believe, however, that you're incorrect by saying "most people don't even calculate cashflow properly." Deferred maint and CapEx are a common expense line item on CF analysis spreadsheets/calcs.

    It depends on what your goals are.  For me, I'd like to get to FIRE as fast and as safely as possible, so cash flow is very important - if not most important.

    0Reply
  • Account Closed
    Investor · Milwaukee, WI · Member since 2013 · 1k+ posts · 1k+ votes
    8y

    It's just not as good of investment as you could have. Let's take your own home. You could buy it cash and then your only living expenses are taxes, utilities and maintenance. Or you could add a mortgage to that, which will cost you plenty in interest. However, you live in that house so you receive a benefit from your money, so the money out the door would be money out the door no matter where you live right?

    Now lets talk about investing your money after you have your residence covered. There are all sorts of investments for your extra cash and efforts out there. Which will you choose? As Kevin O'Leary from Shark Tank says, if your investment is not making any money, it's a hobby. 

    Only you can decide what makes sense and what you want to do. There are always people who do better and always people who do worse, so your only gauge should be against your personal goals. What are they?

    The investment you are doing is fine in every way. It is not however, maximizing your profits and puts a tremendous amount of financial liability in your lap. Where will the money for repairs come from? Can you afford vacancies? So while you have a renter helping out paying down the asset which is good, you have a huge shortfall in funds that will need to be addressed otherwise, you may lose the asset if yo get into trouble.

    These are the simple reasons few investors would accept the sort of investment returns you are accepting.

    And, why not make as much money as you can for the same amount of effort?

    I am but a beginner. I sold my first property last year and if I was not a beginner and had more capital, would not have sold it because it in fact was a great little money maker. I truly believe there will come a time I will look back and realize I have properties in my portfolio that do not perform as well as that property did. So why sell at all right? Well, because I could still do a little better and early on, I really need to max out everything I can to compound my wealth.

    Just like there will always be other investors who do worse or better than you, there will be properties in your portfolio that do better and worse than the others - none of that is bad. Working for nothing on the other hand well, that's called a hobby.

    0Reply
  • Arlen Chou
    Investor · Los Altos, CA · Member since 2014 · 942 posts · 1k+ votes
    8y

    @Maxwell Milholland the question is conceptually simple but in reality the answer is nuanced and complicated.  There are different strategies for different markets and even down to individual buildings.  I am personally a long term buy and hold investor in the SF Bay Area.  When I go into a deal, I analysis it for 1, 5 and 10 year performance based upon my strategy for that building.  I want both sides for the equation: Cash Flow + Appreciation = Wealth.  The question should NOT be which is better, the question should be how to maximize both cash flow and appreciation to get you to the wealth.  

    If you read between the lines of many of the posts, you will see that nobody will accept negative cash flow forever...  Some people may accept it for a short term, until they can implement a plan to get to cash flow.  The issue of appreciation is also similar, nobody successful will hold a property for long if the value of that asset continues to dive toward zero.  At some point the area gets so bad the rents plummet and whatever cash flow you are getting gets eaten up by maintenance and management costs.  The negative extremes of both lopsided strategies would spell disaster.

    The fact is that some markets have strong cash flow but weak appreciation. In other areas, an investor might find very strong appreciation, but very weak cash flow. As an investor the focus has to be on strengthening the part of the equation that is weaker to make your particular asset as strong as possible. Keep in mind that the strategy to accomplish this should be different for SFR's vs multi-family residential vs commercial residential. These nuanced differences often get glazed over but are in fact the key component of putting together a successful strategy.

    2Reply
  • Arlen Chou
    Investor · Los Altos, CA · Member since 2014 · 942 posts · 1k+ votes
    8y

    @Joe Villeneuve you bring up a very interesting question.  In the market that I invest in (SF Bay Area), it gives me appreciation and cash flow.  Getting both is not easy, but it can be done.  In my thesis, I believe that the end goal should be to get to infinite ROI while maximizing cash flow. Meaning, I want to gain AND force appreciation as quickly as I can while staying cash flow positive. Depending upon the asset class the strategy must be different but the end goal for me is the same. But in generic terms, I push to draw out my original investment dollars while keeping cash flow positive. Once all of my initial investment dollars are out of the building, I am playing with "house money", and I continue to build appreciation and increase cash flow. Over a 30 year period monies for cap ex will be paid out of the "house money", either in the form of tapped appreciation or cash flow that is set aside, and therefore does not impact me.

    The natural question is "what happens if there is a crash" and the unrealized value of your property drops. My answer is; as a generational investor, I am planning for my kids wealth not my own, if my ROI is already infinite I don't care what the paper value appears to be. The only issue for me is if rents can cover costs and I can stay CF positive. That could be a dissertation on its own, but needless to say that I look for properties that have low rent at purchase, but have the head room to get to market rents. It just becomes a question of how to get to market rents in a heavily rent controlled region.

    5Reply
  • Account Closed
    Rental Property Investor · Oakland, CA · Member since 2014 · 730 posts · 1k+ votes
    8y

    completely agree with my friend @Arlen Chou

    savvy investors will accept negative cash flow as long as it's temporary. 

    Here is a real life example:

    I am currently negative $6,000/month on a property in Oakland (vacant 5plex). When I bought it, it was cash flow break-even but my plan was to re-position it. Currently it's vacant and hitting me for $6,000/month each and every month. Luckily my other properties are funding this.

    When I'm done re-positioning (total 1 year project), the property will throw off $5,000/month in positive cash flow if I do not pull any money out in a refinance. If I refi and pull my initial capital back ($250K), it will still cash flow $3,000/month. Not only that, I'm doubling the value of the property by forcing the appreciation. 

    Cash flow $3,000/month, have no money in the deal, infinite ROI/IRR, and $500K in equity...all for 1 year of part time work? Sure I'll take that negative cash flow ($72,000 for 1 year) all day.

    Arlen said it right....cash flow + appreciation = WEALTH. 

    4Reply
  • Jonathan Wilson
    Indianapolis, IN · Member since 2018 · 3 posts · 0 votes
    8y
    @Maxwell Milholland, How long have you had the property? Is it possible that you have enough equity built up that you could refinance for a lower payment? That may be enough to bring your property up to the positive. When was the last time you checked comparable properties in the area to see if you’re renting at the same rate as other landlords around you? If it’s been a while, it might be worth it to see what others are getting, so you have a basis for raising your rent. Are there any expenses that you could minimize? I don’t own any properties of my own (yet), but I’ve known a few guys that own various different places, and these are the questions that they ask. Hope this helps.
    0Reply
  • Rae Copitka
    Rental Property Investor · Roseburg, OR · Member since 2015 · 15 posts · 19 votes
    8y

    First, you make your money when you BUY a property, second, a negative is a negative, no matter how you slice it, third, banking on appreciation is risky (2008-2012).

    This question and following explanation is a great example of the difference between an Investor and a speculator. 

    I hope you take what's been shared here to heart and decide which one you want to be.

    1Reply
  • Ana Garcia
    CPA · Miami, FL · Member since 2015 · 134 posts · 83 votes
    8y

    All real estate appreciates in the long run. The goal in real estate investment is definitely to reach the highest return (and cash flow) possible, but a negative cash flowing property may be become profitable and start cash flowing in a matter of a few years, given that rent goes up and expenses remain about the same. 

    0Reply
  • Account Closed
    Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes
    8y
    Originally posted by @Frank Jiang:

    Cashflow is a garbage metric.

    The same house can have positive or negative cashflow depending on whether you put 0%, 5%, 25% or 100% down.

    Most people don't even calculate cashflow properly and fail to account for deferred maintenance or future capex spend.

    It "works" fine for simple deals, but any investor worth their salt is capable of underwriting to IRR.

    Agree. Cash flow is meaningless to judge the quality of an investment. If you change the down payment, interest rate, term of loan etc you can dramatically change the cash flow. IRR or the simpler version ROI (ignores time value of money) are far better metrics of investment. Plus you can use those to compare against other investments. After all what is the cash flow of AMZN stock?

    Where cash flow does matter is when you are trying to generate an income stream to live on. And then that is determined by your spending needs and available capital. If you have $10M in capital and only need $100K to live on you can park it in a savings account. If you only have $1M then you have to generate 10% return on that from your cash flow.

    0Reply
  • Account Closed
    Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes
    8y
    Originally posted by @Ana Garcia:

    All real estate appreciates in the long run. 

    SO far from true!

    1Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y
    Originally posted by @Ana Garcia:

    All real estate appreciates in the long run. The goal in real estate investment is definitely to reach the highest return (and cash flow) possible, but a negative cash flowing property may be become profitable and start cash flowing in a matter of a few years, given that rent goes up and expenses remain about the same. 

     All RE does NOT appreciate...or at least it doesn't appreciate the same every year.  It may go down some years.

    "...may become profitable..." = speculation < investing.

    Rent also doesn't always go up every year.  

    Expenses NEVER remain the same.  Ever have to replace a roof, floors, cabinets, furnace, etc...?  Ever have your taxes go up?  I'm pretty sure those items are expenses, and I'm just as sure they do go up almost every year.

    0Reply
  • Justine Wagner
    Hales Corners, WI · Member since 2017 · 6 posts · 3 votes
    8y
    @Maxwell Milholland. To me it depends. When I was married we had a property that 'broke even'. However our other properties were turning 2% and this property was giving us a tax break and tenant paying the mortgage down in an appreciating area. This house was turn key so I knew no major repairs for 10 years (knock on wood). Our combined income put us in the highest tax bracket so we were in a position that the depreciation, tenant paying down the mortgage and tax deductions helped. Now fast forward to going through my divorce and now I need this property to generate money in my portfolio. With all of the above occurring I can now refinance it and it will net me 1.5% every month while not affecting my other properties. So while the goal in any business is to make money just like the real estate market our personal lives have 'cycles' that paper doesn't take into consideration.
    0Reply
  • Mike D'ArrigoPro Member
    Turn key provider · San Jose, CA · Member since 2010 · 4k+ posts · 3k+ votes
    8y

    It's an asset. It's just not an income producing asset. If it goes on the left hand side of the balance sheet, it's an asset.

    0Reply
  • Ana Garcia
    CPA · Miami, FL · Member since 2015 · 134 posts · 83 votes
    8y

    @Account Closed, I think what you mean is do not invest in a property for appreciation. And I would have to agree. If there is a downturn in the economy just when you need to sell that property because you need the cash, then you are in a bad position. If you invest for cash flow, you have a better chance of survival. 

    However, in today's market there are many investors buying even though they are just breaking even. It all depends on the risk level the investor is willing to accept, the investor's age, the market they are in, the strategy they are following, etc. 

    Ultimately, real estate increases in value in the long run.

    0Reply
  • Account Closed
    Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes
    8y

    @Ana Garcia  That is not what I am saying at all. I have made more money from RE appreciation than any other investment. I am just correcting the statement that ALL RE appreciates. Some RE definitely appreciates over the long term and investing in that is not a bad idea at all. Joe and I actually differ a lot on strategies. He is all about high leverage and cash flow. I am more conservative and play it safer on leverage but do bet on appreciation in high growth coastal markets.

    1Reply
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