In contract on first NEGATIVE CASH FLOW deal, and EXCITED! Thoughts?

35 Replies

I'm getting into a negative cash-flow deal to "speculate" on appreciation and future cash flow, after we can finally rehab the building, and using another cash flow deal to support it. Anyone else doing this? Thoughts?

I recently got in contract on a wholesale deal with a partner for a beautiful Victorian duplex in West Oakland, that I plan on buying 50/50 with another BP investor, where I am borrowing the majority of the capital at a tiered rate for the low-LTV and high-LTV portion.

I estimate there will be at least $100K in built-in equity after the cost of repairs, although it may take some time before the current tenants leave. There will also be good cash flow, and huge appreciation upside in this gentrifying area, once we fix up the interiors and rent to new tenants.

The negative cash flow will only be about $500-700/mo, which I can service out of personal cash flow, and is a bit less than the extra cash flow I'm making from my most recent positive cash-flow deal in East Oakland. I'm estimating that this will be more than made up for by the built-in equity, cash flow after renovations, and opportunity to get into an up-and-coming area for the long-term. In addition, the negative cash flow includes paying off the entire purchase/borrowings of the deal in 15 years.

After reading and researching even more, along with discussion with @Amit M.  , @Minh L. , @Kathryn M.  , I've decided to use some of my cash-flowing properties to support more appreciation-oriented growth on other projects, as a balance toward my goal of building passive cash flow AND more net worth. (I'm sure my recent cash-out appreciation crushing my cash flow didn't hurt my decision either..;) I think this deal could add potentially a couple hundred thousand to my net worth over the next decade, so the $7k/yr or so in negative cash flow for the first some odd years until rehab doesn't seem too bad..

Is anyone else out there using their cash flow properties to support more appreciation-oriented plays? Or projects that need more turnaround or value-added? I sort of jokingly referred to my strategy as being like Warren Buffet's, where he uses the steady cash flow from insurance companies to buy distressed assets or companies that need some turnaround, like he did in the crisis, but I think that's being too generous.. lol

I'm sure I'll also get some grief for "speculating" on appreciation, but I have a thick candy shell, so don't worry about it ;)

Why would you go in 50/50 with a partner if you are bring the majority of the funds on the deal?  Unless your partner has some type of leverage or a good reason why its 50/50 ownership and not the same way on the funds,  I dont see this as being a good situation for you. What am I missing on this issue?

$500-$700 is a lot of negative cash flow per month. How long do you speculate for the turn around where it wont be negative?

Curt Davis, Real Estate Agent in TN (#00321765)

$500-700 per month negative cash flow is a bit beyond my comfort level. I am all for betting on appreciation though, just make sure you play a good defense game and never, ever be forced to sell. 

How much principle pay down will there be monthly?  I'll give up some cash flow in exchange for "equity flow."

@J. Martin  I'd be excited! West Oakland is a great bet. And a bet that I'm looking to make in the near future, too. I live in the Mission. And I'm convinced West Oakland is the new Mission. 

While $700 a month in negative cash flow hurts, Oakland has been experiencing double digit percentage rent increases over the last few years. You'll easily recoup the negative cash flow as you cycle in new tenants. 

Have you checked out the West Oakland specific plan? (warning links to PDF) 

The West Oakland specific plan puts West Oakland on track for smart, and profitable, infill development that will further boost your appreciation oriented investment angle. 

@Curt Davis  ,

I got the deal arranged, making sure everything goes correctly, and operating it, and my partner is putting up the majority of the funds. (I am borrowing almost half, and putting in some of my own cash too.) To put it briefly, the deal would not have gotten done if I was not asked to be involved in it (as she said it). More specifically, I:

1) Got the deal more directly than my partner for ~$5-15K less
2) Negotiated and performed all inspections ahead of other prospective buyers
3) Talked another investor out of the deal at the closing table to get the contract for no more than we originally planned (after over an hour.. one of the stranger circumstances I've experienced in a while, but got a smile, business card, and potential future partner in the process! Ask me another time..)

4) Did # 2 & 3 to get the property in contract while my partner was vacationing in Yosemite!  (No criticism partner! that's what I'm hear for ;)
5) Local knowledge of value & rehab expenses to reasonably accurately estimate upside to decide if deal was worth it, relative to condition, under tight deadline.
6) Live & operate in Oakland, and prepared to negotiate w/ tenants and turn property around
7) Affordable & reliable team in place
8) Thorough landlording processes
9) Time, energy, and expertise to make it a bang-up deal

As far as how long until the negative cash flow stops...? After we rehab the interior. That could be not too long after rehab. Or it could potentially be many many years after rehab. But there are other things I'm gaining in the deal besides cash flow!!! See below..

Wheeeeeeeeeeeeeee!

All aboard the Snowball Express!

Originally posted by @Jon Klaus:

How much principle pay down will there be monthly?  I'll give up some cash flow in exchange for "equity flow."

 Great question Jon! I'll be paying off about $200K in total principal over a full 15yr am, which is about $13K/yr on average, though much less in early years. So for less than $10K/yr out of pocket, I will gain a few thousand a year on average in equity. (My partner and I are both VERRRYYYYYYY long-term buy and holders, so even this 15yr period is much shorter than I plan to have this property.)

Plus about $50K in my share of equity from the improved value on top of the rehab costs(conservative IMHO).

Plus good cash flow once we are able to rehab the interior of the units and re-rent (which will boost the value again by a bunch).

Plus a lot of upside in a gentrifying area (these are the actual market returns -  in addition to the more specific value added by rehabbing the building and increasing the income).

I see these value-added plays, building equity w/ turnaround situation, in addition to turning the building into a higher-renting property to produce cash flow later (even if it's not in yr1 or 2..) will continue to be a good equity and long-term cash flow builder for me. And I have enough cash flow from other projects and my "9-5" to support it. Then choosing spots like these gentrifying areas are what turn triples/homers into grand slams if they pan out as expected.. (IMHO)

So I think a good portion of the expected returns just come from the rehabbing and turning the tenants. Not just "speculation" on market appreciation. But I like that last part as a huge kicker too!  ;)   Just don't tell anyone, or I might get in trouble!

I don't think this is a bad idea.  If you want to grow then you need to look at your business interests in terms of a portfolio.  Different kinds of plays (ie, cash flow, appreciation, flip, etc) diversify the business and don't over expose it to any one factor.

We've been considering buying a couple bare lots to speculate on.  They would be 100% negative from a cash flow standpoint but hopefully pay off in terms of appreciation down the road.  Not really that different from what you've outlined.

Good luck.

^ land spec. No same-same!

It is what it is. California is a completely different animal than I'm guessing most of us are used to seeing. You're buying it right as it sounds like you're gaining 100k in equity. Negative cash flow is tough. But it will right itself eventually as rents go up and your payments stay the same.

If thats what it takes to invest in california, thats what it takes.

And you bring up a good point about your other properties cash flow paying for this one. If this was your first investment, and you'd be looking at negative 700 a month, I'd really be scratching my head (and maybe even some other body parts) on that call.

But the bottom line is that your business (i.e. other rentals) is paying for this one too. So its not like you're coming out of your personal pockets to make this happen. Its still losing significant money in terms of cash flow which is typically an absolute no-no.

But given you're in california and given your other properties are covering the losses, I don't think this is crazy thinking.   Once you reach a certain point in your business, I don't see that there's anything wrong with taking a flyer or two on investments like this - or one like land.

I wouldn't do too many of these deals though at that much of a loss. But nothing wrong with one or two if you think it has some significant upside.....

But I'd definitely recommend against it if it was one of your first investments.....

J,

Why don't you do a cash out refinance after you have stabilized and seasoned it? That should pay-off most of the borrowed money. Then you will have a positive cash-flow property. Take the cash and put it onto the next deal. 

Or go to East West Bank and get a 60% LTV at 4.75% with no docs right off the bat. Take that money and pay back the partner. Use your positive cash flow to pay down/off your remaining 20% principal over time. Just a thought.

Minh Le

    @Minh L. East West Bank does stated income loans? Or is it commercial?

    @Manch Hon  ,

    Why bother going with stated income when they offer no docs? All of these loans are 3/5/7 ARM amortizes over 30 years. I can give an an introduction to them if you want to.

    Minh Le

      @Minh L. I am still hanging onto my W2 job for now. Will keep this in my back pocket. You are right. No-doc definitely beats stated income. 

      I'd say as long as there is a timeline and endpoint for the negative cashflow known ahead of time, it's appears to be a reasonable strategy.  If you know that in X number of months your existing leases terminate and you'll boot the tenants to rehab, it's really no different than any other fix and hold strategy.  You simply add the negative cashflow for X number of months into the cost of the project.  If you can afford to lose $700/month in the interim with the anticipated reward being far greater in a year, there's nothing inherently wrong with the thought process.

      Britt Abbey

        If there is going to be $100k in equity, why not just sell it and take your gains now? You know where I stand on this J, I won't continue to be a debbie downer but $7k negative is a rough investment. 

        Johnson H.

          I haven't done the math, but I wonder if you went with a 20 or 30 year instead of 15 to lower your payments and reduce your monthly negative cash flow? And if you want any given month, pay more to principal. It also depends on how long you think you will hold the building.

          Originally posted by @Johnson H.:

          If there is going to be $100k in equity, why not just sell it and take your gains now? You know where I stand on this J, I won't continue to be a debbie downer but $7k negative is a rough investment. 

           That 100k in stated equity is probably considerably less after accounting for commissions and short term capital gains taxes. On top of that, the remaining profit would be split two ways. 

          Sounds like a classic case of the "greater fool theory." Good luck!

          I remember people betting on appreciation back in 2003 to 2006. The ones that didn't sell lost a lot or everything once the bubble burst. We are almost at another peak in values in CA. Inventory has gone up and once interest rates start going up then watch the values drop. The fed cant keep rates low forever.

          Gordon Cuffe, Lender in CA (#1037464)

          Originally posted by @Alex Hancock:

          @J Martin I'd be excited! West Oakland is a great bet. And a bet that I'm looking to make in the near future, too. I live in the Mission. And I'm convinced West Oakland is the new Mission. 

          While $700 a month in negative cash flow hurts, Oakland has been experiencing double digit percentage rent increases over the last few years. You'll easily recoup the negative cash flow as you cycle in new tenants. 

          Have you checked out the West Oakland specific plan? (warning links to PDF) 

          The West Oakland specific plan puts West Oakland on track for smart, and profitable, infill development that will further boost your appreciation oriented investment angle. 

          Alex, I have not read the entire document, but have heard comments and read articles ad nauseam. I even went to one of the Oakland City Council meetings on it. I love the prospects here too!

          @Bob Bowling 

          choo choo! ;)

          @Jay Hinrichs  

          , funny, I don't even really want a car, but get reimbursed mileage for work. So I bought a 91 Honda Accord w/ 140K miles on it for $1k from a retiring coworker, and have already recovered the entire cost from mileage reimbursements at work. My boss asked me why I bought such an old car when I can afford a lease on something nice or a new car.. Well, that's about as much as paying for this deal until we rehab the interiors! The car runs great, and I don't have to worry about it getting hit or stolen either ;) I do make some personal sacrifices to fund my deals, but totally worth it IMHO.

          Originally posted by @Wade Sikkink:

          I don't think this is a bad idea.  If you want to grow then you need to look at your business interests in terms of a portfolio.  Different kinds of plays (ie, cash flow, appreciation, flip, etc) diversify the business and don't over expose it to any one factor.

          We've been considering buying a couple bare lots to speculate on.  They would be 100% negative from a cash flow standpoint but hopefully pay off in terms of appreciation down the road.  Not really that different from what you've outlined.

          Good luck.

           Thanks Wade. I was considering buying a bare lot to essentially "speculate" on, and was trying to find ways to put some type of livable structure (or RV? Mobile home?) on there for the mean time to generate enough CF to service most of it.. But lots are highly cyclical, and the time expected before developing the lot plays huge into the NPV of the investment, and therefore the price. So if things take off, and developers want the lots, you can get some huge returns. This particular structure is being bought at about half of replacement cost, and they are actually doing new construction around the block. But I don't think an investment like the lot is crazy if it's in the "speculative" portion of your portfolio.. I'll have some other comments regarding this one.

          I wouldn't call this particular deal I'm doing very speculative. It's more like there are holding costs until certain events take place, although the negative cash flow pays off the entire investment on a full 15yr am. So worse comes to worse, and the price is down 20% in 15 years (which I consider extremely unlikely), I will have a paid off asset generating cash flow.

          But I agree with @Amit M.  , it's different buying a bare lot than a building that needs to be turned around..

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