Is this really cash flow negative?

Real Estate Broker · Park Ridge, IL · Member since 2013 · 30 posts · 9 votes

Here in Chicago, we mostly value potential rental investment buildings by it's "Capitalization Rate" which is the property's net annual rental income divided by the property's value. -- 6% or higher is ideal.

I think that adding back tax savings, etc is just sugar coating it. -- You need to have solid cash-flow to give you peace-of-mind.

I'm not trying to steal your realtor's thunder.. -- Just a suggestion.. :-)

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Bjorik Mutize

Real Estate Broker · Minneapolis, MN · Member since 2016 · 530 posts · 398 votes

7y

@Jeremy Segermeister

Simplified cash flow

Income

-Expenses

-Debt service

=Cash flow

All the immediate inputs and outputs. Yes tax savings and depreciation is nice but I don’t see that on a month to month basis. I look at it as appreciation, a nice add on to look at end of year.

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Junior Soares

Contractor · San Jose, CA · Member since 2018 · 262 posts · 407 votes

7y

@Jeremy Segermeister We are not a good place for cash flow, unfortunately. Those who purchased in the Bay in the 90s are the ones who are cash flowing. For our generation we need to take our money to the midwest as those are great cash flowing markets. The west/east coast are appreciation plays but need big money tied up for a long time. I'm sure you can generate amazing returns with 200k cash out of state instead of thing it up on a negative cashflow property just to bank on future growth. I have a rental in Brentwood, CA which is negative $150/m cashflow. This is ok for me because it's one of my appreciation plays which I've gained quite A bit of equity in the 3 years I've owned it. I knew coming into this one that it would put me in red, but during tax time it pretty much washes with write offs. I then have smaller multi family and SFR's In the Midwest which were a fraction of the cost but generating me consistent 10% COC returns after all possible expenses. These properties will likely never go up in value but that's fine because I'm not in these markets for that. I'm in it for the cash flow to save and buy More.

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Ali Boone

Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes

7y

Originally posted by @Anthony Dooley:

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.

I'm a little late to the conversation but I agree with exactly this explanation.

The depreciation/tax benefits are one of five ways to make money on a rental property:

Monthly cash flow
Appreciation
Tax benefits
Equity build via mortgage pay-down
Hedge against inflation

People can argue all day long that a property cash flows, but in somewhere like SF they are grouping all of the profits centers into one category to say you're making money. And maybe you are, but that's not considered monthly cash flow in your pocket.

The thing I consider with a rental property is-- if I can aim to get income from all 5 of those profit centers, I have room for 1 or 2 of them to not pan out in a year or more and I can probably still profit. If I automatically eliminate any of those profit centers from the get-go (i.e. monthly cash flow), I'm narrowing my pool of options for where to get income should any of the other peter out for some amount of time. Of course CA/SF banks hard on the appreciation, more than most cities, but while we're closer to peak than crash in the real estate market right now? Not quite the appreciation play it could be if properties were on sale during a crash instead.

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John Duston

Accountant · Santa Barbara, CA · Member since 2016 · 213 posts · 66 votes

7y

@Jeremy Segermeister

I'm a tax professional and you're getting baf advice. The expanses aren't what you deduct, it's the loss.... unless this realer is advocating fraud.

Either way, it's bad advice and I suggest you find a new realtor. I know a few in the area if you'd like a recommendation

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Richard Patrie

Morrisonville, NY · Member since 2013 · 61 posts · 46 votes

7y

I don't factor in appreciation when calculating cash flow. I don't assume what might happen. If it does appreciate, that's great. If the value tanks, which is a real possibility, then you're holding the bag.

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Justin Hammond

Investor/Developer · Salt Lake City, UT · Member since 2015 · 207 posts · 106 votes

7y

@Jeremy Segermeister

As far as your question about changing strategies, that completely depends on your goals.

If your goal is to generate passive income, you may want to look elsewhere or find your own off market deals.

If your goal is simply to preserve your nest egg, the Bay Area would be a good place to do so.

What would you say is your main reason for wanting to invest?

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Irina Belkofer

Real Estate Broker · Cleveland, OH · Member since 2017 · 719 posts · 658 votes

7y

Originally posted by @John Duston:

@Jeremy Segermeister

I'm a tax professional and you're getting baf advice. The expanses aren't what you deduct, it's the loss.... unless this realer is advocating fraud.

Either way, it's bad advice and I suggest you find a new realtor. I know a few in the area if you'd like a recommendation

It's not a bad advice per se - it's a realtor's view of financial matters. She might be a good realtor, just don't take advice on money from her, only houses.

Think for yourself.

Cash flow has very specific definition - google it and you'll know if you're cash flow positive or negative.

Besides, some people invest in places where appreciation is not a consideration. In your location it is and the major one. Right now, foreign investors buying up houses in certain parts of SoCal and don't even bother to rent it out (because California is not landlord friendly state) - they just plan to sell it when it's doubling in value. Not like I'd do it myself, but for each their own.

Don't judge a frog by his ability to climb a tree - it will think that he's a looser.

Investing in different places has different goals....once it works for you - that's all what's matter

Good luck!

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Gretchen P.

Rental Property Investor · Littleton, CO · Member since 2014 · 150 posts · 114 votes

7y

Most Real Estate agents don't understand rental property, find one who does.

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Account Closed

Investor · Milwaukee, WI · Member since 2013 · 1k+ posts · 1k+ votes

7y

The only positive there is that you have an entity that is not you (your renter) sending you money each month. It's a great thing, until you compare it to the "sales" of other sorts of businesses, and realize it's peanuts.

The play you are considering is the extremely long term play. And, your numbers will require you pony up too, to finally purchase that money machine you covet.

Depreciation is simply a way to expense the cost of the property, like any other business expense. You don't get to deduct your mortgage payment AND take depreciation, you get depreciation in place of the mortgage payment deduction.

Why are you relying on your agent for investment advice? Their job/motivation is to sell property.

I dunno...what do I know? I'm but a minnow. Seems to me the "purchase property for the deduction" strategy is for people who have so much other income, they are trying to minimize their annual taxes by taking on a few "losses". It's what people do after they have already become successful, not what they do trying to get there.

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Account Closed

Investor · Milwaukee, WI · Member since 2013 · 1k+ posts · 1k+ votes

7y

Originally posted by @Irina Belkofer:

Don't judge a frog by his ability to climb a tree - it will think that he's a looser.

What does this mean? LOL.

1 Reply

Michael Ealy

Developer · Cincinnati, OH · Member since 2018 · 1k+ posts · 3k+ votes

7y

Originally posted by @Account Closed:

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.

Jeremy,

I've acquired over 1,000 apartment units and I don't like the way your real estate friend calculates what she refers to as "cashflow".

There are 2 numbers to consider in every investment:

1. Cashflow or yield

2. Over-all profit or return

Cashflow is Rent - expenses
Over-all profit = annual cashflow + appreciation + loan paydown + tax benefit (depreciation, interest deduction, etc)

Cashflow can be negative but the over-all profit can be positive (that's what your friend is really saying). BUT, that's only IF & WHEN the appreciation materializes (and that happens when you sell the property).

With the market being up, and hot there in SF Bay Area, I am not sure how long that will stay that way. Maybe it will go up 2-3 more years from now but what if it goes the other direction? Then you can have negative appreciation and negative profit instead.

If you're not comfortable feeding an alligator (negative cashflow property), then don't "swim" in the "appreciation market". The alligator could eat you :)

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Holly Williams

Rental Property Investor · New York City · Member since 2014 · 208 posts · 271 votes

7y

I'm in NYC, so I feel your pain. That said, my accountant tells me that "passive losses offset passive income", so many multifamily syndications cash flow, but show paper losses because of appreciation. There is a lot of information on this site, and many people who you can speak with about it...just search multifamily syndication and off you go.

There are also passive opportunities in just about everything else, such as self-storage, mobile home parks, etc. I know less about those, but others here do. Especially if you are an accredited investor, it's lots less hassle.

Happy to chat, and others here will freely share their knowledge and personal experiences as well.

Best of luck to you!

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John Duston

Accountant · Santa Barbara, CA · Member since 2016 · 213 posts · 66 votes

7y

@Irina Belkofer

A professional should be able to answer a question with a fairly accurate response or disclose that they are not an expert on that area. (Hopefully giving a referral.)

I don't believe that telling a client that a rental is cash flow positive off of a gross misinterpretation of how taxes work without disclosing that they are not competent in that field can mean they're a good realtor for investments.

In my industry this is really important. I am a good tax prepare but if someone asks me about nonprofit, government accounting, or legal, I may give a little advice but also disclose that I'm not strong in those areas. To do else wise as an accountant can lead to loosing your licenses depending on the severity and motive (such as trying to close a big commission).

1 Reply

Shawn M.

Investor · New Haven, CT · Member since 2012 · 285 posts · 175 votes

7y

@Jeremy Segermeister

ice cream sundae time

Cash flow (money in your pocket each month) is the ice cream

Everything else ( depreciation, debt pay down, deductions ) is the whip cream and cherry.

Can’t have a sundae without ice cream

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Jonathan R McLaughlin

Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes

7y

That's essentially an IRR calculation. Perfectly valid methodology. Useful in many circumstances and you should become comfortable with it. Only as good as the assumptions made. But it ain't cash flow, two different things. Cash flow is a component of total return.

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Mike Freske

Attorney · Minneapolis, MN · Member since 2018 · 62 posts · 36 votes

7y

@Bill Brandt

I would not recognize loan pay down as income until the property is sold and you sell for more than the loan. It’s not realized until then.

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Bill B.

Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes

7y

@Mike Freske

I like your plan Mike, it would certainly lower tax liabilities. Heck, i would just make extra payments so every property was slightly cash flow negative. But, I don’t want to be in tax court, explaining how I didn’t know any better. The IRS says you have to recognize income when you earn it, even if it is used it to pay down debt.

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Is this really cash flow negative?

Is this really cash flow negative?

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