Is this really cash flow negative?

Buying & Selling Real Estate
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Is this really cash flow negative?

Account Closed
San Jose, CA · Member since 2019 · 64 posts · 26 votes

Hi All,

I'm still debating investing in my home market of the Bay Area, CA, or doing a STR in Maui.

Despite preferring to invest locally, I originally ruled out the Bay Area simply because I didn't think I could get something to cash flow - I'm simply not comfortable "losing money" each month and relying on appreciation. I've been working with what feels like a fantastic investor friendly agent (whom also has a finance background). However, she sent me an investment model that I simply don't understand. 

- My interpretation of cash flow is simply the mortgage payment minus expenses. 

- Her model incorporates the tax benefits associated with the investment property (mortgage interest, depreciation deduction etc. ) and also adds an appreciation assumption. 

Example using arbitrary numbers - 

  • Gross Rent: $1,000/month
  • Gross Expenses (HOA, tax, mortgage + interest,): $1,200
  • Depreciation: $300
  • Marginal Tax rate: 30%

I perceive this as a negative $200 cash flow. Because of my income, I can't claim a loss.

Her model takes the expenses + depreciation ($1500), calculates the tax savings associated with the property ($1,500 x 30% = $500/month). Therefore her claim is that the $1,200 in expenses is really $1200-$500 = $700 and thus a $300/month cash flowing property.

Am I crazy for being confused by this? She is saying I could adjust my W2 witholdings from my employer to achieve the same thing if I wasn't comfortable being negative each month.

Perhaps someone here can help? I'll also be reaching out to a CPA to clarify.

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Bill B.
Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
7y

Again. Nobody is counting the $300/mo in principle pay down. That IS INCOME. 

Taking the tax rate off real expenses make no sense at all, that’s not income and a very bad comparison. 

I’ve told the story before but I have a negative $500/mo cash flow property that makes $12,000/year before the $16,000 depreciation. Meaning I make $12,000/year taxfree and I’m carrying $4k/year in losses forward. (I bought for appreciation and eventual retirement while it was “affordable”)

That said, I’m not saying this is a good deal, I’m just repeating that more than 90% of the experts on here found the entire mortgage payment as an expense. It’s 100% a negative cashflow event but not 100% an expense. 

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  • Anthony G
    Rental Property Investor · Indianapolis, IN · Member since 2012 · 91 posts · 41 votes
    7y

    From what I see depreciation is the only loss that you could actually add back to your cashflow if you wanted to. The others are all real losses so tax savings on a loss is still a loss. So the way I see it you could take $300x.30(tax rate) and add that back to the monthly cashflow if you were so inclined (I don't think most people do). However, if your income is too high to deduct rental losses the tax savings will never materialize because you are already taking a loss on the basic monthly expenses. Your -$200 cashflow calculation would be how most people calculate a property's cashflow, but I noticed you didn't add anything for maintenance or repairs so you would probably be even further negative and depending solely on appreciation.

    4Reply
  • Chad Kastel
    Rental Property Investor · NY · Member since 2018 · 126 posts · 42 votes
    7y

    @Account Closed.  Ditto what Anthony said about maintenance, Cap Ex etc..    This may be the formula that you're forced to use in California to try and justify deals. You would 100% consult a CPA to find out if these numbers work and make sense.  Since you'll likely going to be doing it again. I don't know what you do from work, but if you could find a way to get other passive income you can also write the passive loss's from the real estate against that and save tax's on what you otherwise would've paid on that income.  Investing in a good accountant is always worth it.

    1Reply
  • James M.
    Rental Property Investor · Seal Beach, CA · Member since 2016 · 115 posts · 85 votes
    7y
    I deallt with a similar situation down here in Southern California. My real estate agent who was savvy was trying to tell me the same thing. And yes it is true you will get money back at tax time due to depreciation but I personally do not calculate that into my analysis of a property. On top of that, you are now adding income from the property on top of your already high income, so who knows what your tax situation truly looks like unless you sit down with a CPA. I have never heard of anyone calculating an roi based on an expected tax return. For the most part here in California, the only way I can find any deals are those with some sort of value add. With all that being said, given our soft current market, if we do pull back a bit, now your depreciation isn’t what you originally expected either.
    2Reply
  • Frank Wong
    Real Estate Broker · Bay Area · Member since 2018 · 1k+ posts · 3k+ votes
    7y

    When I invest I don't bank on the depreciation and tax savings it's all about cash flow.  The Bay is tough because of the prices and its very hard to the net each month.  You will need to put 50% down or pay cash.  This is an appreciation game out here. 

    1Reply
  • Account Closed
    OP
    San Jose, CA · Member since 2019 · 64 posts · 26 votes
    7y

    Thanks everyone. That’s what I thought. I’ll have to talk to my agent and see if it is possible to find a cash flow positive deal excluding tax and depreciation.

    0Reply
  • Michael T.
    Los Angeles, CA · Member since 2018 · 326 posts · 279 votes
    7y

    @Account Closed are correct.  Don't include depreciation and tax savings as part of your formula.  

    While I love appreciation and tax savings it is not something you should count on in your analysis.

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

    Your agent is trying to sugar coat a bad deal to make the sale..

    Yes depreciation and tax benefits are a part of the total equation, but they are the icing on the cake.....not the cake itself.

    Don't tweak and spin things to justify it being a good investment..... you are rationalizing yourself into making it a good investment, when its not. It may be "ok" because of some of the these more fringe benefits but you can do better.

    I'm in CA and I am in the same boat....cant find squat that will actually cash flow or be a good value add at a decent price....

    3Reply
  • Account Closed
    OP
    San Jose, CA · Member since 2019 · 64 posts · 26 votes
    7y

    @Michael Tripp thanks, that’s what I thought. Since the market is tough to get something to cash flow, does that mean I should consider changing my strategy and do a flip rather than buy and hold?

    Is that a better strategy for these high cost markets?

    Jeremy

    0Reply
  • Tanner Marsey
    Rental Property Investor · San Diego, CA · Member since 2017 · 439 posts · 578 votes
    7y

    Pass. Yes, you can factor in depreciation but keep in mind your rental “income” (even if break even) still counts as income during tax time. Going to be a grind to find instant cash flow in the bay. Gonna be a long game/appreciation play. Good luck!

    0Reply
  • Jason D.
    Rental Property Investor · St. Petersburg, FL · Member since 2017 · 3k+ posts · 4k+ votes
    7y

    @Jeremy Segermeister it's an even worse deal that you've presented.

    What about insurance?

    Maintenance?

    Reserves for future capital expenses?

    Reserves for vacancy?

    That $300 negative is probably closer to $600 a month negative.

    Appreciation is not cashflow, it's a capital gain realized upon the sale

    Depreciation is not cashflow, because it is recaptured upon the sale.

    You're realtor may not be as investor friendly as you think.

    5Reply
  • Dennis M.
    Rental Property Investor · Erie, PA · Member since 2018 · 6k+ posts · 9k+ votes
    7y

    This isn’t rocket science . It’s what’s left after you paid all expenses .it’s the amount each month in profit to put in your back pocket . If you have nothing to put in your back pocket each month then you probably shouldn’t buy it .

    4Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y

    @Jeremy Segermeister @Dennis M. This is definitely cash flow negative, by a lot. You’re not even accounting for vacancies and maintenance etc.

    This is slightly off topic but I had a good conversation last night at a local meetup about appreciation and cash flow investing. For me investing for appreciation is great but you need a solid base cash flowing assets first.

    Also I never understood, if you want appreciation why not invest in a value add syndication as a LP? You'll get some cash flow, likely 6-10 percent CoC return and you're way more diversified then buying a single family home in say California.

    3Reply
  • Bill B.
    Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
    7y

    Again. Nobody is counting the $300/mo in principle pay down. That IS INCOME. 

    Taking the tax rate off real expenses make no sense at all, that’s not income and a very bad comparison. 

    I’ve told the story before but I have a negative $500/mo cash flow property that makes $12,000/year before the $16,000 depreciation. Meaning I make $12,000/year taxfree and I’m carrying $4k/year in losses forward. (I bought for appreciation and eventual retirement while it was “affordable”)

    That said, I’m not saying this is a good deal, I’m just repeating that more than 90% of the experts on here found the entire mortgage payment as an expense. It’s 100% a negative cashflow event but not 100% an expense. 

    5Reply
  • Dennis M.
    Rental Property Investor · Erie, PA · Member since 2018 · 6k+ posts · 9k+ votes
    7y
    Originally posted by @Bill B.:

    Again. Nobody is counting the $300/mo in principle pay down. That IS INCOME. 

    Taking the tax rate off real expenses make no sense at all, that’s not income and a very bad comparison. 

    I’ve told the story before but I have a negative $500/mo cash flow property that makes $12,000/year before the $16,000 depreciation. Meaning I make $12,000/year taxfree and I’m carrying $4k/year in losses forward. (I bought for appreciation and eventual retirement while it was “affordable”)

    That said, I’m not saying this is a good deal, I’m just repeating that more than 90% of the experts on here found the entire mortgage payment as an expense. It’s 100% a negative cashflow event but not 100% an expense. 

    But how much did you pay for that property ? 

    1Reply
  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    7y

    Depreciation is NOT cash flow. Depreciation will reduce your taxes on the income that you would have made IF this deal cash flowed. Since it doesn't cash flow, you are bleeding money each month while waiting for appreciation. You cannot benefit from appreciation unless you either sell or do a cash out refinance, both of which are expensive. After you sell, you will pay capital gains taxes and real estate commission. So, you really have to wait a long time to make any money.

    3Reply
  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    7y

    I have family in the Bay Area and suburbs. I have looked into investing there and tried to make sense of it, but I can't. It absolutely doesn't make sense to me to make 3% cash on cash on a D class property there when I can make 20% elsewhere. And I don't even include tax benefits or projected appreciation in my numbers. To me, that is a cherry on top.

    1Reply
  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    7y

    @Account Closed It's highly doubtful that your agent will find you a deal. They are only looking on the MLS. You can do that yourself. To get a good deal in a market like that, you have to market to sellers. You have to find distressed property that is not on the market that nobody else knows about. Nobody else is bidding against you. An agent only shows you property listed on the MLS because otherwise, they may not get paid.

    0Reply
  • Bill B.
    Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
    7y

    @Dennis M.

    Paid $450k, zero out of pocket (downpayment was from refi on existing property that this property pays, hence the negative cashflow. I count the other property as still 100% paid off.) that was almost 3 years ago, it appraised for $620k at the end of the year so I’m paying off both loans and getting one cheaper loan. In the end I’ll have zero $’s in to the deal, the original property will be free and clear again, $170k in equity, $12k in tax free income, and $4k in carry forward losses. 

    Again, it’s my only negative cashflowing property and I bought it for personal reasons, the investment part was secondary. I want to pay it off before I retire there as I no longer itemize my personal expenses. The plan is a free retirement home that has given me $400k in depreciation and so far a couple hundred thousand in appreciation that I will leave tax free at my passing. 

    They aren’t all about money, sometimes it’s about plans and maybe dreams. 

    1Reply
  • Eric Carr
    Real Estate Broker · Los Angeles, CA · Member since 2017 · 658 posts · 293 votes
    7y

    Here's the thing, I use that model also depending on the circumstances - I'll mention those in a minute. But with that, you are looking at a long term (probably) reward. And you are looking at making your cash flow payment at tax time. I've done this in high appreciating areas, paid out of pocket for two years, and then watched the place appreciate 100%, rents rose, and it cashflows. If you believe the areas are going to be at least stable and still be around in 5 years, and you foresee (as much as you can) the upside, it's an investment choice. Otherwise there are other areas in the US that will provide cash flow today. You get to choose

    0Reply
  • Arif Siddiqi
    Rental Property Investor · San Jose, CA · Member since 2018 · 42 posts · 22 votes
    7y

    @Anthony Dooley same here, after living in Bay Area for 10+ years and analyzing multiple cash flow scenarios, I have found you can’t get a true cash flow property and flipping is the name of the game over here. In last 3 months, I have acquired 5 cash flow positive properties in Midwest area at a price for which you can’t even get a 1 bed condo in Bay area. If you are looking for positive cash flow residential rental properties, stop wasting time and look for the greener pastures in the east, while enjoying superb weather over here.

    2Reply
  • Jason D.
    Rental Property Investor · St. Petersburg, FL · Member since 2017 · 3k+ posts · 4k+ votes
    7y

    @Bill Brandt are you counting the loan pay down as "tax free income"?

    I'm trying to follow your plan, but I'm not seeing the advantage here.

    Why not buy a property that doesnt take $4k per year out of your pocket?

    3Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    7y

    You need to find a new agent. Your agents only objective is to make a sale. She could careless if it's a good investment for you. She is selling you smoke and mirrors. Get rid of her.

    0Reply
  • Account Closed
    OP
    San Jose, CA · Member since 2019 · 64 posts · 26 votes
    7y

    Thanks everyone for the support. @Arif Siddiqi - when you say flipping is the name of the game in the Bay Area, have you been able to find deals with enough spread between the purchase price and ARV to warrant the effort? I'm being told getting contractors lined up could take 3 months or more, so that adds to your holding costs.

    0Reply
  • Arif Siddiqi
    Rental Property Investor · San Jose, CA · Member since 2018 · 42 posts · 22 votes
    7y

    actually I am not involved in flipping myself but I have seen a few investors doing that over here. My investment philosophy is to go for buy and hold positive cash flow rentals generating at least $150/m after accounting for every possible expense. I don’t count depreciation or any other tax incentive in my calculations for the similar reasons many other informed investors pointed out above. I am myself a newbie and just started investing a few months ago and now have 5 plus rentals and one more under contract, all using heloc from my principal residence and having a good credit history to qualify for 20% downpayment 

    2Reply
  • Bill B.
    Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
    7y

    @Jason D.

    It is tax free income. No one on BP seems to count loan pay down even though every webinar on BP counts it as one of the sources of rental income  

    Imagine in 15 years. The property hasn’t gone up one more penny. I can pull out 75% of $620k (call it $450k) during that time I have put $6k/year or $90k in. So I have $360k extra in my pocket and $170k in equity that came from somewhere in those 15 years. If it’s not income what is it? And not only did I not paying any taxes on it, I’ve paid negative $60k in excess depreciation I use against other rental income. $530k in 15 years isn’t retirement type money, but it’s not zero or worse yet negative money either. 

    But even better, it means I can I retire in a $600k-$1million (assuming 3.5% appreciation/year) lake house for Just the taxes and insurance, call it $4k/year. Because I kicked in $90k along the way. 

    I could also just sell it in 15 years because I choose to retire somewhere else, then I have $620k-$1million minus closing costs for my $90k out of pocket. But then the tax guy is gonna come looking for his $80 - 140k and I only made $400-$800k in 15 years on this loser. 

    Ps. Did I mention when I die someone gets a free lake home tax free? :-) wish I was there to see their face. 

    2Reply
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