Cutting your losses or holding negative cashflow?

Question

I was listening to an older episode of bigger pockets today and they brought up the discussion of a negative cashflow rental, specifically in the context of turning a principle residence into a rental property. I could use some insight on the numbers below:

In the episode they discussed a principle residence that now cash flowed -100 a month. That said I can't get my mind around cutting the losses on the property because of the following:

Given the home had a 300k 30 year fixed, 5.25% loan, the payment would be $1,656 a month. I constructed an amortization table in excel and noticed that each payment had a principle portion of $344 from payment 1, increasing each month as the property is held longer.

What I am wondering is that a negative cash flow of 100 is actually a positive $244 payment as the principle portion paid down by the debt service paid by the tenant nets in the home owner's favor. So is it really such a bad thing to hold this fictitious property given that the vacancy rates are low, and given that tenants are of decent quality? Even a 1 month vacancy seems to be offset by the principle paid down during the first year in excess of $4,128 (monthly principle portion x 12 months, understand that the principle portion grows over time and these are just ballpark numbers).

What are your thoughts? Any first hand experience? In my newbie opinion the numbers seem to align that if the cash flow isn't detrimentally negative $100 a month is a small price to pay for the debt service paid down.

Jay Hinrichs · Answer

@Stephen Chittenden

in a non appreciating market then your catching a falling knife.. I just had one of mine be reassessed for flood insurance and all of a sudden a break even is 300 a month negative. with no apprecaiton. I kicked out the tenant and put it on the market .. even if I have to cut a 10k check to get ride of it that is what I will do because it will never go up and never cash flow take the loss this year since I have big gains in other areas... another one gone.. then only 7 more freaking rentals and I am free   free at last from tenants  LOL. I over exaggerate but you get the drift.. if it was a prime property in CA or even here in Oregon and I was 300 a month neg I would hold but not in a market that does not demonstrate any real upward movement

Engelo Rumora · Answer

I would cut losses and start of fresh.

When I first started I had over $1m in debt and was loosing money every month.

It was a recipe for disaster. I was fortunate enough to quickly wake up and smell the roses and sell out of my portfolio.

Real estate investing should be about cashflow and loving life on your terms. Only cashflow can enable you to supplement the income from a job that you might not want to be doing.

As the saying goes "If Cash is King then Cashflow must be Queen" lol

Just my 2 AUD :)

Thanks

Stephen Chittenden · Answer

A lot of good stuff here.  As a former homeowner who rents out that property at a whopping $500+ (previously $700+) monthly loss (non-deductible to boot), I am not a big fan of holding properties that lose money.  We've had the tenant not pay rent for 3-4 months.  We've had the tenant leave and require repairs of over $7,000.  We've spent $5,000 on upgrades and finishings to try to sell and let the place sit empty for four month after we had to evict yet another tenant.  We can carry it, but it is no fun.  It's like an albatross.  If we could have sold it without needing a lot of cash at closing, we would have.  On the plus side, in only 5 more years, the home equity loan will fall off and the place will basically break even.  I think it is snake bit though.  Tenants look great on paper and then have unexpected issues... job losses, etc.  If you can get rid of it, I would do it.

Randy E. · Answer

@Gregory Lomelin, one thing I would worry about would be repairs and vacancies.  With a cash flowing property, a landlord will be able to set aside a portion of the monthly cash flow to handle negative surprises associated with the property.  With a negative cash flowing property, that's not possible.

A homeowner/investor might be able to easily handle losing $100 a month.  But what happens if tenants move out suddenly and the landlord has to pay the full $1600 mortgage for two months?  Or worse, pay $1600 x 2, and pay another $1500 to fix up the home for a new tenant?  Or, what happens when tree roots compromise the sewer line in the front yard and the homeowner has to pay $3000 to a plumber to put in a new sewer line?  That might not be so easily absorbed if the homeowner is steadily losing money every month BEFORE the negative surprise.

Some homeowners/landlords might earn enough from their W2 job to easily absorb such down months.  Other homeowners/landlords might be in a more fragile financial situation.  Before you make the decision to carry a negative cash flow property, make sure you're financially able to manage the negative surprises and vacancies.

Account Closed · Answer

What are your thoughts about emerging out of your period of negative cash flows? Was it worth it? What about the equity, not necessary appreciation but the paid off portion of the loan assuming the loan represents approximate market value today? Also, is it wrong to assume that so long as the negative cash flows, be it by repair or vacancy or both, fall below the principle loan service is amount that it can been seen as a positive? Or that the negative cash flow was worth it? Of course a single answer cannot fit all situations, but is it possible that in a given circumstance you would consider a negative cash flow "worth it"?

Stephen Chittenden · Answer

The market actually has appreciated.  We just bought in 2006 at the top of the market, basically.  It fell flat on its face in 2008, and the home probably lost about 20% of its value.  The home has appreciated to the point where we're we could sell and cover most all of the costs associated with selling.  Our biggest issue is that we came on the market a little early (because that's when the tenant was evicted) and we ran out of time to sell it before we didn't want to pay the entire mortgage ourselves anymore.  I also think that we were pushed into listing it too high, which I was afraid of based on what I could see from other listings and sales.  I think we wasted two months priced above market.

Cutting your losses or holding negative cashflow?

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