Invest in a negative cash flow property for appreciation?

40 Replies

Hi, for the experts who are investing for appreciation, will you invest in a negative cash flow property if the appreciation is almost certain? The property I am thinking about is a ~1.3M purchase, no rehab necessary, at a monthly negative cash flow of ~$1,700, and the conservative appreciation projection is 6-7% per year.  Why or why not?  What else should I factor in other than purely numbers?  This is a SF Bay Area property, B building condition in a A neighborhood of a A town. 

@Yuki K.

I do not factor appreciation into any deals. Appreciation is not almost certain, so many factors could change it and you'll be stuck with a negative cash flow property and potentially underwater. If you base your analysis on the items you know are certain and in your control (i.e. taxes, rent etc.) then most events that could sink you won't hurt much.

I know that real estate plays in places like the bay area and NYC are their own animals, you should try best to limit your risk. For example, I had a property in NYC that was cash flow negative $100 a month, but profited over $100k in appreciation in just 4 years. However, -$1,700 per month is excessive risk IMHO.

Best of luck in your decision!

I would look for better cash flow if possible. Negative cash flow means less leverage available to you, more against your DTI. I just bought a property in bay area for 900k that cash flows. They're out there

Nothing in any investment space is "certain."  Not even cash flow.  A property that cash flows on paper may in fact cause you large cash losses for years due to unexpected/unforeseen capital expenditures or skillful professional tenants who evade eviction for months or years, etc.

We invest mainly in the Bay Area (in Marin and we also dabble in SF).  Both buy and hold and flips.  (Today's environment is more conducive to flips if you can find inventory but FWIW we are holding on to one property we purchased last October).   We do not invest "for appreciation."  We invest to build wealth rather than to collect a few hundred bucks per month as our principal goal (though, of course, we do not say "no" to some cash flow when available).  Investing in real estate to build wealth has several key components, including, yes, anticipated appreciation above the level of inflation (many people who should know better often confuse the two) over an anticipated holding period of at least 10-15 years, a value-add strategy (this is important but often overlooked), mortgage paydown (a kind of money market account) and, yes, cash from rents.  In this market two well-purchased single family homes in, say, 2012 for hi 600's or low $700's should together gross about $120,000 in rents today and have combined market value of about $3 million today with modest improvements over the years.  With Prop 13, the property taxes have not moved much at all.                     

A fix and flip in San Francisco can certainly force appreciation....but a housse that is purchased "rent ready" is going to be negative cashflow from Day 1 at 20% Down  99.9% of the time. 

@Yuki K.

How is the property priced relative to comps?

Seems like you will be burning roughly 20k a year and anticipated appreciation at 6% is 78k. So in theory you are coming out ahead.

The big win here is if you are getting the property below market comps. Then your appreciation has a huge head start. Say the property is 10% below market, you have 130k in equity from day 1 and then 6% compounded on top. By year 2 your property appreciation is at 300k roughly with a total cash burn of 40k.

I do agree with a post that you will never conventionally break even on cash flow. But that’s not to say you won’t build wealth.

@Yuki K. dont do it. I have a couple of those in the Bay area and I'm finally getting rid of them. Appreciation is great but you can't get it without paying taxes on it unless you get a bigger mortgage and then you have even more negative of cash flow.

I am finally offloading one into an opportunity zone but honestly if I had it to do all over again I just wouldn't do it without cash flow.

Is your loan principle pay down greater than your negative cashflow? (In other words are you actually making money?)

My only negative cashflow property I bought 7 years ago. A townhome on the lake. 

Rent $36k, income $20k, cashflow negative $9600. It’s appreciated over $200k. But I was making money day 1 as my negative cashflow was less than the principle pay down. In another year when the loan is paid off it will go to positive $24k cashflow. 

So at the end of next year I’ll have $75k in negative cashflow, a $200k capital gain and a paid off unit. If I don’t do a cash out refi, 3 years later I’ll have all my money back and a paid off property. 

Just increase your down payment til you are cash flow neutral.

Change your thinking to view properties as they exist without leverage. All properties cash flow. I'll say it again. All properties cash flow. When they dont, it is because your leverage is too high.  

The risk of the negative cash flow on the property is not due to the property, it is because of your leverage against the property. Drop the leverage amount, til you are break even or cash flow positive. 

Originally posted by @Darius Ogloza :

Nothing in any investment space is "certain."  Not even cash flow.  A property that cash flows on paper may in fact cause you large cash losses for years due to unexpected/unforeseen capital expenditures or skillful professional tenants who evade eviction for months or years, etc.

We invest mainly in the Bay Area (in Marin and we also dabble in SF).  Both buy and hold and flips.  (Today's environment is more conducive to flips if you can find inventory but FWIW we are holding on to one property we purchased last October).   We do not invest "for appreciation."  We invest to build wealth rather than to collect a few hundred bucks per month as our principal goal (though, of course, we do not say "no" to some cash flow when available).  Investing in real estate to build wealth has several key components, including, yes, anticipated appreciation above the level of inflation (many people who should know better often confuse the two) over an anticipated holding period of at least 10-15 years, a value-add strategy (this is important but often overlooked), mortgage paydown (a kind of money market account) and, yes, cash from rents.  In this market two well-purchased single family homes in, say, 2012 for hi 600's or low $700's should together gross about $120,000 in rents today and have combined market value of about $3 million today with modest improvements over the years.  With Prop 13, the property taxes have not moved much at all.                 

This is probably the best answer to your question.  Cash flow and appreciation are both random variables, they are both typically positive but both have an element of uncertainty, which is why I disagree with the "cash flow" is real and "appreciation" is a mirage mentality. The two questions I would ask you are 1) can you handle the negative carry, and 2) what is your holding period?  If the answer is yes, and 5+ years out I would say go for it. 

You could buy an apartment complex in the midwest for 1.3m and cash flow 10k/month, just estimating using 50% expense rule. I’d rather have 120k/year cash flow than speculating on SF appreciation of 78k/year. Especially with tech giants adopting forever telework and who know if interest rates may rise again one day.

Yeah. The faster telework takes over the faster the 50+ year long trend of people leaving states with snow and income taxes will accelerate. People already know about Florida Texas and Nevada. Maybe you can beat them to Tennessee. The newest todo weather no state income tax state. But I'd also be bailing on multifamily unless your plan is section 8. Remember the last recession? SFR rent up and MFR stopped coming in.

I know plenty of people are bullish on SFO and Bay area....but also some things working against you.  My gut says don't do it, but I'm sure many will say SFO area is it's own animal with it's own set of dynamics.   

What rent can you get for $1mil place in SFO?   Who's your target market?  What size is that market?  What's your vacancy?

$1mil purchase price, then your target rent should be around $10,000/month.  To me that's a pretty thin market and very transient when you find them.  If they are there long term, they probably should be looking to buy.  If they're not buyers, then they're probably there on short term corporate rotation....so you get move in/move out every year or two...which costs you money for make ready, lease up, and vacancy.   Just something to think about.....

Are people moving to or from CA?

Do you like rent control?

Taxation of "wealthy" people seems to be the talk of the day in CA.   How does that affect your capital gains?

Originally posted by @Russell Brazil :

Just increase your down payment til you are cash flow neutral.

Change your thinking to view properties as they exist without leverage. All properties cash flow. I'll say it again. All properties cash flow. When they dont, it is because your leverage is too high.  

The risk of the negative cash flow on the property is not due to the property, it is because of your leverage against the property. Drop the leverage amount, til you are break even or cash flow positive. 

Exactly. Negative cash flow is just deferred downpayment.

 

Originally posted by @Bruce Lynn :

I know plenty of people are bullish on SFO and Bay area....but also some things working against you.  My gut says don't do it, but I'm sure many will say SFO area is it's own animal with it's own set of dynamics.   

What rent can you get for $1mil place in SFO?   Who's your target market?  What size is that market?  What's your vacancy?

$1mil purchase price, then your target rent should be around $10,000/month.  To me that's a pretty thin market and very transient when you find them.  If they are there long term, they probably should be looking to buy.  If they're not buyers, then they're probably there on short term corporate rotation....so you get move in/move out every year or two...which costs you money for make ready, lease up, and vacancy.   Just something to think about.....

Are people moving to or from CA?

Do you like rent control?

Taxation of "wealthy" people seems to be the talk of the day in CA.   How does that affect your capital gains?

The Bay Area is not Coppel Texas. Its not even Dallas Texas, Maybe closer to Austin TX but even that's not the same. For the above $1M property in the right area your target rent is 3500-4000. Your tenants are tech workers making a combined income in excess of $200K per year. Your vacancy is effectively 0. You can self manage because these people always pay rent. The market price is not determined by rents. Its determined by home buyers. A dual income tech couple can easily afford $1M plus homes. Again. it is not Texas.

 

@Anish Tolia    I moved here from Bay Area and to Bay area from Singapore.  Used to live almost next door to Oracle HDQ, which is now moving to Austin.  Not everyone will move, but gradually those high paying jobs are moving to Austin, Dallas, Houston, Nashville, Atlanta, and other places.  Same with NYC.  Companies like Goldman Sachs have figured out, Manhattan is not the center of the universe for financial talent.  Now there are 3 GS HDQ, with more employees in Dallas area than NYC.  No sense investing a mil for $3500/rent.  Then you'd be way more negative cash flow than OP indicates when you include taxes and insurance, capex, and PM (if you use one) and any other expenses like vacancy and make ready and lease up fees.   Plenty of places to invest with less risk and higher returns.   There's always turnover, so vacancy is never zero....if dual income couple can afford $1mil homes, that's my point...why do they rent from you....almost never will they be long term renters if they can be buyers.

I only go for cash flow and some appreciation properties. Check out Fresno or other surround cities. 

@Yuki K.

It entirely depends on your situation. If you have built-in 10-15% reserve(5% for vacancy, 5% for capex, 5% for maintenance), I believe you should be fine. However if you are getting the property financed, banks will look for DSCR of 1.15 to 1.25. They may ask you to put lot more money down to bring to +ve cash flow. Just my $.02 cents advice.