Buy property in Bay Area with negative cash flow for first 2 year

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Buy property in Bay Area with negative cash flow for first 2 year

Nuo Shi
Member since 2020 · 17 posts · 2 votes

I'm a first time investor. 

Currently, looking into a fourplex in Bay Area, the rent is 2100, due to the landlord didn't increase rent for past 6 years. If the rent increase to 2400, I can break even, while the pre-covid market rent is 2450-2500 around. Can I use the strategy to increase rent by (5%+inflation) for continuous two years? I think this is allowed by rent control. The current lease is month to month, so if tenant doesn't want to renew, I can have a small remodel and put that into market. At least, I think for the first year, a 2250 rent is still competitive. Does that sound reasonable? 

I read a lot of articles which mentioned cash flow is the king in real estate investing, however, almost impossible in Bay area. Does that make sense to tolerate a negative cash flow for first two years?

Yeah, I don't know whether in the next few years there will be a deflation, but with consideration of fed simulation and QE, there is also a good chance for inflation.

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Patrick Mallen
Real Estate Agent · Bay Area, CA · Member since 2018 · 7 posts · 4 votes
6y

We are in a hard market to find cash flowing properties and a especially hard market for house hacking where the rent you collect covers all expenses. That being said if your out of pocket costs are less what you would pay in rent for the same place it would make sense. You are also building equity over time, have tax advantages, and will most likely be able to increase rent to cover the expenses over time. 

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  • Patrick Mallen
    Real Estate Agent · Bay Area, CA · Member since 2018 · 7 posts · 4 votes
    6y

    Hi Nuo, 

    I do not think that it would be smart to have negative cash flow even it is just for a period of time. You also have to think about maintenance and other expenses as well. It would make sense if you are living in one of the units and renting out the others, and their rent covers most of the mortgage, leaving you with expenses that would be less than market rent in the area you are buying in. If you have any questions feel free to message me. 

    Best, 

    Patrick 

    1Reply
  • Nuo Shi
    OP
    Member since 2020 · 17 posts · 2 votes
    6y

    @Patrick Mallen

    Oh, right. I forget to mention I plan for house hacking. For the negative cash flow, I included the mortgage, maintenance, tax, insurance, vacancy in expense; for income, I calculated 4 units including the one I plan to live in. Not have enough coverage for the large repair yet.

    In that case, what's your insight for the period negative cash flow?

    1Reply
  • Patrick Mallen
    Real Estate Agent · Bay Area, CA · Member since 2018 · 7 posts · 4 votes
    6y

    We are in a hard market to find cash flowing properties and a especially hard market for house hacking where the rent you collect covers all expenses. That being said if your out of pocket costs are less what you would pay in rent for the same place it would make sense. You are also building equity over time, have tax advantages, and will most likely be able to increase rent to cover the expenses over time. 

    2Reply
  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    6y

    @Nuo Shi. Are you saying the 3 rented units would cover all your expenses? Or are you saying the 3 units cover 75% of the expenses, and you'll be covering the rest of mortgage out of pocket, as you'll be living in the fourth unit? In a house hack, run your numbers as if you are not living there. If that makes you have zero cash flow, then you're taking a huge risk that the market will continue to increase. It's what caused the housing market crash around 2008. 

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  • Nuo Shi
    OP
    Member since 2020 · 17 posts · 2 votes
    6y

    @Anthony Wick

    Ya, I calculated the number as if I was not there. I always hear people saying cash flow is the king, and sometimes wondering why this is the case. Does that apply to all?

    For my case, I did some stress test for the financial side, and confident that we can pay the negative cash flow out of our own pocket for years without stress sale. We are not actually losing that money, instead we are building the equity. I agree if the market drops, we will lost the opportunity to invest on some good deals with potential higher Coc return. Since my strategy is to buy and hold for long term, is there any insight why the negative for the first few years can still be a high risk?

    With our bay area hot market and my zero investment experience, it's almost impossible to find a deal to allow me break even initially. But I do want to enter the real estate arena to learn the new world. Appreciate any advice

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    6y

    @Nuo Shi. First, I will acknowledge that Cali is whole different animal. I lived in Sacramento for 8 years. I'm well aware of what it is like there. And I would not own or live there again. 

    Second, this could work out very well for you. But let's call it what it is....speculation. Those of us that like and insist on cash flow also speculate that we will get appreciation. But while we are buying and holding and speculating, we are cashing checks and making profits on monthly cash flow. 

    Third, a house hack is also a totally different animal. You can compare house hacking to renting, if that's the situation you're moving from. I did that once upon a time too. I was paying $1,200 rent and then bought a duplex wherein I only had to cover $600 to make PITI after collecting rents. Now, was I cashing checks? Not really. But, I was lowering my expenses and gaining equity in real estate. As a matter of fact, I actually continued to "pay" my same $1,200 each month. I just paid it into my reserve funds, to myself.

    So, I'm not sure anybody can tell you to go ahead and do this deal. We don't know the future. Are you buying at the top of the market? I have no idea. But if you feel comfortable with your area and the future, this could absolutely work out great for you. Perhaps your worst case scenario is the market drops, but your costs stay the same. If I was going to pull the trigger on a deal like this, I would just make sure I am 100% comfortable on the possibility of filling vacancies. 

    I hope the deal works out well for you now, and in the future. 

    1Reply
  • Joe Bertolino
    Investor · El Dorado Hills, CA · Member since 2012 · 1k+ posts · 1k+ votes
    6y
    Originally posted by @Anthony Wick:

    @Nuo Shi. First, I will acknowledge that Cali is whole different animal. I lived in Sacramento for 8 years. I'm well aware of what it is like there. And I would not own or live there again. 

    Second, this could work out very well for you. But let's call it what it is....speculation. Those of us that like and insist on cash flow also speculate that we will get appreciation. But while we are buying and holding and speculating, we are cashing checks and making profits on monthly cash flow. 

    Third, a house hack is also a totally different animal. You can compare house hacking to renting, if that's the situation you're moving from. I did that once upon a time too. I was paying $1,200 rent and then bought a duplex wherein I only had to cover $600 to make PITI after collecting rents. Now, was I cashing checks? Not really. But, I was lowering my expenses and gaining equity in real estate. As a matter of fact, I actually continued to "pay" my same $1,200 each month. I just paid it into my reserve funds, to myself.

    So, I'm not sure anybody can tell you to go ahead and do this deal. We don't know the future. Are you buying at the top of the market? I have no idea. But if you feel comfortable with your area and the future, this could absolutely work out great for you. Perhaps your worst case scenario is the market drops, but your costs stay the same. If I was going to pull the trigger on a deal like this, I would just make sure I am 100% comfortable on the possibility of filling vacancies. 

    I hope the deal works out well for you now, and in the future. 

     If Bay Area real estate has appreciated an average of 4.66% a year for 100 years is it really speculation?   Not three years,  or five years, or ten years... 100 years.  Bay Area incomes have risen 31% since 2018.   Every new IPO creates several hundred to a few thousand new millionaires.  For the Bay Area,  a flat market seems ice cold because they are used to being white hot.  This pandemic will blow over and things will get back to normal.  Some people with leave,  some people will come... same with every other world class city.   Any dip is fairly temporary.  Same with NYC.

    To answer the OP's question.  If you are house hacking and can buy a Bay Area 4 plex with 3.5% down and a interest rate in the 3's... while push rents up to market rate and it is not a huge financial strain on you... then do it.   In 5-7-20 years will will be very, very happy that you did.  

    2Reply
  • Justin Thorpe
    Member since 2020 · 437 posts · 675 votes
    6y

    @Nuo Shi

    Are you looking to collect 2100 for 4 units in the Bay Area? That sounds quite low to me. Which part of the bay is this?

    As for negative cash flow, it depends on how your property is valued vis a vis comps. If it is deeply undervalued then I’ll take the negative cash flow.

    If it is valued at par or overvalued, negative cash flow is a bit risky although the Bay Area has had historic appreciation behind it.

    To me cash flow equals total cash flow which is the monthly cash flow plus appreciated value of the property when you sell.

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    6y

    @Joe Bertolino. Well, let's answer your question with another example. If the stock market has averaged 7% a year gains over the past 80 years, is investing in the stock market this year speculative? The answer is, of course.....YES!!! Your example will maybe make the OP feel good about investing, but it doesn't mean buying any property that has a negative cash flow is not speculative. I wonder if those that lost their homes in and around 2005-2010 feel better because property values on average have gone up over the past 100 years. 

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    6y

    @Justin Thorpe. I disagree that appreciation is also "cash flow". You do not realize those gains until they are actually earned and realized. $20,000 appreciation this year means nothing if property values drop $30,000 next year. You can spend cash flow. You can pay bills with cash flow. You can do maintenance and capex with cash flow. You cannot do much with appreciation until it is realized. I know you mentioned "when you sell". But this is a buy and hold. I simply would not call speculated appreciation "cash flow". It may be semantics, but that's the way I see it. 

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  • Brian Garlington
    Realtor · Oakland, CA and a Real Estate Investor with Multi-Family Units and a Self Storage Facility · Member since 2016 · 2k+ posts · 2k+ votes
    6y

    Cashflow and Bay Area generally are not in the same sentence. Buying for negative cashflow and hoping for appreciation is even worse. It is unfortunately not uncommon for landlords to have not raised rent here in the bay area for a long time. 

    Best advice,...look in Oakland/Richmond Areas....generally those are the higher cashflowing markets in the bay area. Do not "fall in love" with a property because it might cashflow "someday". When you do find one that cashflows here in the bay area be prepared to move fast on it because it won't last on the market long. If your realtor isn't sending you properties that cashflow, find one who will.

    1Reply
  • Joe Bertolino
    Investor · El Dorado Hills, CA · Member since 2012 · 1k+ posts · 1k+ votes
    6y

    @Anthony Wick

    * has negative cash flow with under market rents and he is living in a unit. He will be paying rent somewhere. My advice was if he was comfortable carrying it then go for it. Long term buy and hold investors in the Bay Area typically do quite well. Buying with 3.5% down and rates near 3% is a no brainer for me. You can certainly make arguments not to but in 5 years he would regret not doing it.

    1Reply
  • Randy Klafehn
    Member since 2018 · 4 posts · 1 vote
    6y

    @Nuo Shi Never buy on a dream. The numbers make sense on a spreadsheet then go for it. Keep in mind local rental laws for the city your looking in. Month to month in SF is no different than a life time lease with a small annual increase based on CPI. Are the tenants protected? Also keep in mind that if its in an outlying area, soon a rental prices go down in the city, People will move to the city and your rents will go down dramatically.

    Put all your numbers into excel and put several scenarios togeather to create a risk profile. Look up rental prices changes from 2008,9 etc to help with your build your worst case scenario. Say one -10%, -5%, flat, + 1,2,3,4%. Go in eye wide open if the numbers work then your Golden. If there’s a downturn your not in a panic. Talk to a CPA or someone who is impartial to crunch the numbers.

    0Reply
  • Justin Thorpe
    Member since 2020 · 437 posts · 675 votes
    6y

    @Anthony Wick

    As a local Bay Area investor you will agree that this market does not kind itself to cash flow. I have been investing in the area for 20 plus years and I know cash flow is not easy to create at the outset of an investment.

    But I have experienced success in terms of appreciation and have been fortunate to build a sizable portfolio over time. Some assets purchased have doubled and tripled in value.

    The biggest variable is the entry price and the valuation of the property. If you are lucky to get it below market price, chances are you have a winner on your hands.

    1Reply
  • Wilson Pun
    Member since 2020 · 23 posts · 9 votes
    6y

    As some of the other posters have mentioned, unless you can purchase a property at substantially below market, taking on negative cash flow means your play is either to profit with a flip (which doesn't seem to be your intention), or gamble on appreciation- and it is a gamble.  Real estate appreciation has certain seen tremendous growth in many markets, but many believe we may be nearing the end of a market cycle and heading into a period of low or no growth (if not negative), with negative cash flow is a big risk.  I see the same difficulties in finding cash flowing properties in NYC.  You can always consider investing in out-of-state markets.

    0Reply
  • Nuo Shi
    OP
    Member since 2020 · 17 posts · 2 votes
    6y

    Wow, thanks for everyone's insights. I do love the BP forum.

    For my case, I have to mention this is not a 3.5% down yet 25% and I don't think the property is below market value with similar comps. I believe this is a really bad ROI for experienced investors. Since I have a full time job and zero experiences, I try to stay away from some c/d class neighborhood, which might have better cash flow opportunity, so the option for me is very limited. Considering the OOS, it has to find some trustable network and local connections, which I don't have yet.

    I agree, I kind of gambling appreciation in Bay area, with the data from 2008-2018 (peak - peak for the last cycle), Bay area has a 5% appreciation per year. I'm hesitate to say this gonna to repeat, but can I assume a 2% appreciation considering inflation?  IMO, Bay area has strong economy with lots of job opportunity. 

    0Reply
  • Ian WalshBusiness Member
    Lender · Philadelphia, PA · Member since 2016 · 2k+ posts · 1k+ votes
    6y

    I would not buy with negative cashflow.

    0Reply
  • Allan C.
    Rental Property Investor · Member since 2018 · 828 posts · 811 votes
    6y

    Let's put aside covid implications for a moment. Most who advise to not buy in a high cost location and only buy CF properties likely do not have deep experience in high cost locations. As others noted, if you have the liquidity to manage a few years of negative CF while maintaining adequate reserves, then buying in the bay can be a significant wealth generator. There is a separate thread at the moment with proponents of high appreciation markets.

    I disagree with the notion that you cannot monetize appreciation until you dispose an asset. When rental demand exceeds supply, the marginal investor is buying property at current market rates, thus will be the future market maker for rent. Therefore if you purchased at any lower price than the marginal investor, you'll capture rental income growth with appreciation. 

    In high cost markets, you have to analyze your investment on an IRR basis, not simple CoC. Your cash flow realization will be uneven, so you'll need to account for time value of money.

    You'll also want to diversify your investments, so having a mix of appreciation plays with cash-flow assets will be ideal. 

    Covid implications in mind, buying in the bay is a different issue, but there's no need to rehash all those view points again on this thread.

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