Purchasing A 4 Unit Property With Negative Cash Flow. Bad Idea?

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Purchasing A 4 Unit Property With Negative Cash Flow. Bad Idea?

Steven Smith
Castro Valley, CA · Member since 2018 · 14 posts · 19 votes

Hello Everyone. 

I'm in the process of closing on a 4 unit building in CA in which I will live in one of the units. I will be raising rents about 8% since the current owner hasn't raised rents in a long time. Even if I eventual move out and make it investment property, I'll still be negative CF of at least $200 to $300 a month. I know that BP has guidelines about cash flow being the driving force in buying investment property. 

Would this still be a good investment since equity would grow from rents collected? 

What are your thought?

Thanks everyone!! 

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Lindsey Iskierka
Real Estate Agent · Long Beach, California (CA) · Member since 2016 · 73 posts · 43 votes
7y
@Steven Smith I’m in Long Beach, CA where multi family homes are expensive and finding an investment that cash flows right away is like trying to find a unicorn. I’m a realtor in the area as well so I’m really familiar with the local market. If you think of “house-hacking”, it’s where you live in the property and utilize roommates or other units on the same property to help pay your mortgage. You either live for free or for cheap! If you are living in the property and are only $200-$300 negative cash flow, I suppose that’s what you’re ultimately paying each month for your mortgage after rents. Over time, rents could appreciate and meanwhile you’re building equity, paying down your loan and living for very very cheap! Just as a personal example, my husband and I bought a triplex in Long Beach in October 2016 for $750,000. Rents were below market and units needed to be updated. Over the last two years we’ve renovated all 3 units and raised rents while the market was still appreciating. When we first moved in, we were paying about $1800/month after rents (VERY cheap for our area!). Now we pay about $1400/month and if we were to move out and rent all 3 units we would be positive cash flow about $700/month. So right away, it wasn’t a terrific deal but after renovations and increasing rents, it’s now a good deal and will continue to be a well-performing property for us. So if you are house-hacking have the expectation that you may not be cash flowing or living for free yet, but you may over time if you force the value of your property up through renovations and value-adds. I hope that helps!
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  • Steve K.
    Realtor · Boulder, CO · Member since 2016 · 3k+ posts · 5k+ votes
    7y
    @Steven Smith What are the rents for each unit and what do you anticipate raising them to? What are your expenses all in/ NOI. If we know those numbers to determine current cap and pro forma we‘ll have a better idea if it‘s a sound Investment. In my experience properties tend to cost money in the first few years until you get them performing and catch up on hidden deferred maintenance issues, deal with things that come up, make changes, etc. Do you have cash reserves to carry the property for a while?
    1Reply
  • Judy Parker
    Rental Property Investor · Closter, NJ · Member since 2015 · 884 posts · 722 votes
    7y

    @Steven Smith Can you purchase at a lower price, which would reduce your mortgage payments?  Also, you may wish to file a tax appeal/tax grievance, especially since the property is negative cash flowing.

    0Reply
  • Jack B.
    Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    7y
    Originally posted by @Kevin Christensen:

    @Steven Smith I would be real iffy about that if all of the units are already rehabbed.  That means you can't really force appreciation, which tells me you are basically tying up your money for a slow equity leak that you have to contribute to.  You could probably use that money much more effectively on a break even or slight cash flow property.  Imagine what happens if you're tying up all that money, plus 200-300 per month and something breaks in the near future? Now you're REALLY putting out fires with cash.  Doesn't seem like a great deal to me, but I'm basing that on just what you've said here.

    Very well put.

    0Reply
  • Account Closed
    Member since 2018 · 25 posts · 6 votes
    7y

    Hey Steven,

    I did the same thing about 2 years ago. I bought a 3 family with a va loan and still live in it. I did what some are suggesting here and raised rents one unit at a time. I didn't take the slow approach though. One tenant opted to move out and i got a new tenant a month later for more than what i was going to raise on the old tenant. the other tenant decided to stay and i came down $100 a month for him to be responsible for taking out the garbage and shoveling the snow over the winter. 

    For the unit that left, i hired a cleaning company for $150, laid down some carpet tile, and repainted. although the cabinetry and bathroom/kitchen was dated, in my area, it wouldn't have added much value. 

    That said, i'm totally with your plan!

    0Reply
  • Megan Phillips
    Rental Property Investor · VT · Member since 2017 · 233 posts · 147 votes
    7y

    What's the demand for rentals in the area? I'm concerned less with current negative cashflow based on below market rents, and more with the idea that you seem afraid to instantly raise rents to market rent/turn over tenants.

    If there is a strong rental market, buy the property, raise rents to market value immediately (or after the current leases expire), if tenants stay, great. If they leave, you can get new tenants which would already be used to paying fair market rent - either way, you're getting fair market rent. There shouldn't be apprehension to do that just because the tenants are "used to it."

    1Reply
  • Heather Schmidtknecht
    Rental Property Investor · Winona, MN · Member since 2018 · 87 posts · 90 votes
    7y

    I have been in this situation... and I don't recommend it.  When I remarried 4 years ago, I moved my family to my new husband's home and put a FOR SALE sign on mine.  Because I didn't want it sitting open over the winter, when fall rolled around, I rented it out.  My rent covered my large mortgage, but I paid heat/sewer/water/trash/taxes/insurance (because if I would have made someone else pay any/all of that, I would have never found anyone to rent it).  To the point, I was putting at minimum $300/month toward that rental.  While it's true that if I had held onto it until the mortgage was paid, I would have a little cash flow then... the stress and the headache until that point is not something I would advise.  I was lucky never to have a vacancy in 4 years, but if I would have, it would have sunk me. 

    I had an emotional attachment to that house, and when it finally sold this past summer, I had a really hard time.  HOWEVER, selling it opened many doors for me that were previously locked tight -- like investing in real estate with cash flow!  :)

    If it's too late to get out of this deal, my advice would be to build-up your cash reserves/emergency fund so you don't have to stress over vacancies and/or repairs/maintenance.  Good luck!

    0Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    7y

    All properties cash flow. 

    Let me say that again

    All properties cash flow.

    Now if you are leveraging the property, that does not change the underlying fundamentals of the asset, but rather it is you the investor by choice (or in most peoples case by necessity) that creates a negative cash flow situation by adding debt to the equation.  And the more highly leveraged you are, expect to have less cash flow, or more negative cash flow.  I dont think you stated how leveraged the asset is, but in most cases its simply not  a reasonable expectation to expect to  cash flow with a super highly leveraged asset.

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  • Scott Williams
    Rental Property Investor · Clarksville, TN · Member since 2017 · 18 posts · 24 votes
    7y

    How much of the mortgage will you be applying as part of your rent in the 4plex. It appears to me that you said it would be 300 negative with all rented out currently. The point of house hacking is to reduce expenses, but it seems you will be still paying a portion of it. Will househacking reduce your current expenses for housing? If not I suggest you find another deal that you may apply the BRRR method to.

    0Reply
  • Ned J.Pro Member
    Investor · Manteca, CA · Member since 2017 · 1k+ posts · 2k+ votes
    7y

    I'm in CA and yes, there are plenty of millionaires with negative cash flowing properties...... but those are properties that will flip to positive via management cutting expenses, increasing NOI and/or forcing appreciation...... or they play solely on the appreciation angle....which can work if you can play the long game and have plenty of reserves to fund that long game.

    You either find a way to flip to positive cash flow in a reasonable time...increase rent, decrease expenses etc....or you play the long game of appreciation and have plenty of reserves to ride it out during the tough time.

    1Reply
  • Derek Joyner
    Flipper/Rehabber · Winston Salem, NC · Member since 2018 · 33 posts · 24 votes
    7y
    @Steven Smith I say no it’s a bad investment. If you read Rich Dad Poor Dad. This is considered a liability not an investment. This should be a game of buying assets not liabilities. So if it cost you money every month then it’s a liability every month. That simple.
    0Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    7y
    Originally posted by @Russell Brazil:

    All properties cash flow. 

    Let me say that again

    All properties cash flow.

    Now if you are leveraging the property, that does not change the underlying fundamentals of the asset, but rather it is you the investor by choice (or in most peoples case by necessity) that creates a negative cash flow situation by adding debt to the equation.  And the more highly leveraged you are, expect to have less cash flow, or more negative cash flow.  I dont think you stated how leveraged the asset is, but in most cases its simply not  a reasonable expectation to expect to  cash flow with a super highly leveraged asset.

    I agree it is unreasonable with a highly leveraged deal to expect cash flow. This deal is a $600K property with $24K down, so he has 4% into the property and it will negative cash flow $200-300 per month. I bet most people telling him to pass on the deal, probably own properties that wouldn't cash flow if they were 96% leveraged either! I don't consider this a a bad deal given the location. Most people would have to put 20% into a deal like this, which would be $120K. Even if he is subsidizing it $300 a month, that extra $100K equals 27 years worth of $300 payments! 

    But we all know it won't lose $300K forever. Rents go up, but the payment is fixed (minus tax and insurance). Over time this property will turn cash flow positive and will appreciate significantly.

    4Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    7y
    Originally posted by @Joe Splitrock:
    Originally posted by @Russell Brazil:

    All properties cash flow. 

    Let me say that again

    All properties cash flow.

    Now if you are leveraging the property, that does not change the underlying fundamentals of the asset, but rather it is you the investor by choice (or in most peoples case by necessity) that creates a negative cash flow situation by adding debt to the equation.  And the more highly leveraged you are, expect to have less cash flow, or more negative cash flow.  I dont think you stated how leveraged the asset is, but in most cases its simply not  a reasonable expectation to expect to  cash flow with a super highly leveraged asset.

    I agree it is unreasonable with a highly leveraged deal to expect cash flow. This deal is a $600K property with $24K down, so he has 4% into the property and it will negative cash flow $200-300 per month. I bet most people telling him to pass on the deal, probably own properties that wouldn't cash flow if they were 96% leveraged either! I don't consider this a a bad deal given the location. Most people would have to put 20% into a deal like this, which would be $120K. Even if he is subsidizing it $300 a month, that extra $100K equals 27 years worth of $300 payments! 

    But we all know it won't lose $300K forever. Rents go up, but the payment is fixed (minus tax and insurance). Over time this property will turn cash flow positive and will appreciate significantly.

    Yeah I missed the part where the down payment was 4%. Yeah its just not simply to be reasonable to expect positive cash flow at that....and that is because it is not an investment property loan. It is an owner occupant loan. People need to have different expectations for a property that is solely an investment with 20-25% down versus a property they will occupy with an ultra low down payment, PMI and the such.

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  • Anthony Cettina
    Investor · Jacksonville, FL · Member since 2018 · 18 posts · 5 votes
    7y

    @Steven Smith

    Thanks for sharing!

    Ultimately, you gotta do what you think is right.

    Another point to consider, if you haven't already, is this:

    You are estimating a negative cashflow of $200-$300. Is that under the best conditions? Have you accounted for vacancy and any needed repairs that may come up? (Example, if one or more units is NOT being rented out, how long can you sustain that additional cost.)

    Also, do you have a solid exit strategy? If you're not living in it forever and paying the additional rent yourself, as you mentioned, will someone else be willing to front the higher cost for that unit or is that going to be up to you?

    Just some thoughts!

    I wish you the best!!

    Anthony Cettina

    0Reply
  • Ryan Enk
    Covington, LA · Member since 2014 · 292 posts · 102 votes
    7y

    @Steven Smith, I wish that early on in my investing career that I really understood the difference between investing and speculating. Your situation the way you described it is speculative. Sure, you COULD end up making great money in the end. And if that’s a risk you are willing to take them take it.  But it’s still speculative. And you probably can find some other deals that are cashflow positive on day 1, without having to speculate on the rise of rents or on the market appreciation.

    0Reply
  • Steven Smith
    OP
    Castro Valley, CA · Member since 2018 · 14 posts · 19 votes
    7y

    @Joe Splitrock Thanks. How do I change the cap rate? Currently from my worksheet it's showing a 6.63 purchase cap rate. As someone stated, that's not uncommon in CA. 

    @Steve K. Monthly expenses: $4,564.75 Monthly income (after a small rent increase): $4,250.00. I could raise rent more to tighten the numbers. And I do have cash reserves to carry the property for a bit. (Hope I never have to). 

    @Russell Brazil That is correct. I'm not bringing in much and since this a VA loan, I don't want to. I don't plan to live on the property forever, but when I leave I'd like to have it stable and producing something if only a little as I move on to bigger (or smaller) things.

    @Judy Parker Waiting on the appraisal to come back. I think asking price is a little on the high side, but a lot of value add is already done. We'll see if I can get a lower number. Also considering buying points to get the interest rate down. 

    Some here suggested that I immediately raise the rents to market rate. I agree now. (Sorry my future tenants). 

    One other thing I have done (Don't know if this is right) is, on paper, increased rents to market ~$1195 each unit (instead of the small increase mentioned above),  I took out things like cap ex, regular maintenance, etc, and I end up with ~$200/month cash flow. I don't need this money right now so 100% if it will sit in an account for things that go "bump" in the night. I know that's not much, but it's better that loosing that amount each month

    I know the BP way is always separate "Cap ex" (for instance) and other variable expenses from profit and as much as I believe in BP, I feel I can use my own mind for some decisions.  (That's what God gave me a brain for). :-)

    Forgive me as I continue to learn this new part of my life in Real Estate. I know I will make mistakes along the way, but I'm tired of sitting on the sideline. 

    Thanks everyone.

    3Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    7y

    @Steven Smith there is three ways to change the cap rate, increase income (rent), decrease expenses or decrease purchase price. You are not bad at 6.63. Raising rents will help, but you can only raise to market level. You can improve the property to increase rents. Sometimes you can reduce utilities by energy saving methods such as higher efficiency fixtures. You can bill back utilities to tenants, but that is basically a rent increase so be mindful of overall cost to tenants. 

    0Reply
  • Gregory Washington
    San lorenzo, CA · Member since 2017 · 33 posts · 36 votes
    7y

    Never good to invest in negative cash flow. Ever

    0Reply
  • Lee L.
    Investor · Los Angeles, CA · Member since 2014 · 285 posts · 142 votes
    7y

    @Steven SmithDon't be surprised if your once great tenants become the devil tenants after you raise their rent. The tenants might start giving you more service calls, and playing games. Someone might decide to move, or stop paying you. Make sure you can weather these risks. Otherwise if the area is promising, and the deal is solid, go for it!

    0Reply
  • Sam Shueh
    Real Estate Agent · Cupertino, CA · Member since 2016 · 4k+ posts · 1k+ votes
    7y

    What is the projected appreciation rate in the next few years?

    Sam Shueh


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  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    7y

    3-5% is my range. 4% is what I target. I wont typically buy outside my range.

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    0Reply
  • Pat JacksonPro Member
    Rental Property Investor · Reno, NV · Member since 2017 · 284 posts · 137 votes
    7y
    @Steven Smith no dude! Would Warren Buffett subsidize renters and call it an investment?
    0Reply
  • Luciano A.
    Developer · Houston TX · Member since 2018 · 423 posts · 400 votes
    7y

    @Steven Smith 

    I am not a big fan of investing in a deal in which you dont make money from day one. If you arent getting cash flow or wont have equity when you buy it makes the deal hard to swallow. 

    However, you mentioned you have always wanted a 4plex and dont mind living in a 4plex. A typical first time buyer might buy just to live in for a year or so but if you can see yourself living in it for say 5-7 years (if you have to) then you are using the tenants to help pay down the mortgage and eventually might be able to use appreciation strategy down the line to move out and eventually turn into an investment. Did you see how many times I used eventually. It is risky but if you can carry the negative amount per month, potential vacant unit from time to time then you can hold until property cashflows. 

    I remember my first deal I had to sale everything to get into the deal and was fortunate not to loose my shirt. I wouldnt recommend to everyone but you sound like a person who can take the risk and fight through it. If you are prepared to hold onto it while you get rents up then I would not discourage you. However, I would say at this point it would not be an investment but more of an opportunity to buy your own home with the help of a few tenants. It is like buying a SFH and renting out the rooms. The rents might not cover all your cost but you get to own a piece of the American Dream.

    1Reply
  • Luciano A.
    Developer · Houston TX · Member since 2018 · 423 posts · 400 votes
    7y

    @Russell Brazil . I agree with what you had to say. Coming in with little money to the table will leave you making little money out of the investment. Leverage is great if you use it correctly. You must be a great asset to your investment clients in your part of the country. Always appreciate an agent who can speak investors language.  

    0Reply
  • Luciano A.
    Developer · Houston TX · Member since 2018 · 423 posts · 400 votes
    7y

    Remember this property is still considered a residential property not a commercial. Banks and appraisers use Comps to figure price. They will use the rents it generates as a way to look at the property but the area and other 4plexs sold in the area will give its value. Commercial properties and or 5 plus unit multi-family is how you should use NOI,Cap Rate. Doesnt do any good to use to analyse a single family property.

    1Reply
  • Jim Costa
    Investor · Washougal, WA · Member since 2016 · 86 posts · 52 votes
    7y

    I agree with @Joe Splitrock You have to look at the big picture.  You are paying "market rent" of $1195 +300 for a $6000k piece of property.  When you take into consideration your $8-10K in principal depreciation ...first year, as well as your $30K interest write off, not to mention depreciation ... your property will cashflow.   @Steven Smith   Be sure you check the leases and tenant laws of how much you can raise the rent.   It seems you are buying right (from an owner who hasn't raised rents in awhile). be sure you know your numbers.  Are these studio apartments? $1200 sounds very cheap for Castro Valley.  Not from area but familiar with it.  A quick Zillow search shows cheapest rent in all of Castro Valley at $1650 for a 450 sqft studio.  I think you are undervaluing your rents.  I'm sure you have done the research but seems like a lot of opportunities in rent.   If market rents are truly $1600-$1700 you can really house hack and live for free.  

    Most buyers make the mistake of undervaluing CAP EX. However, if you have recent updates , roof, appliances, windows, interiors, Your CAP EX will be cheaper. Seems like a good deal to me for the area you will be buying in.

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