Would you buy for future cash flow vs current?

28 Replies

I found an off market deal that is just slightly below the market rate, so I wouldn't walk in with much equity. Both units are currently rented out, and at the current rents, the property would have positive cash flow, but minimal.

However, the current rents are around $300 each for a duplex, so $600/month below market rent rate for the area.

My question is - would you buy a property that off the bat would have low cash flow, but once rents were where they should be would have great cash flow?

I've evaluated multiple deals like this and I like to make sure that it is cash flow positive off the bat even if it is lower than market rent. Then I also run numbers on market rent. I want to make sure both numbers work for my business. What is the current lease situation? Are they month-to-month? If so, it shouldn't be hard to get rent up. Does the property need a lot of rehab?

@Alex Heidenreich thanks for your reply! One unit the tenant has been there for 8 years and is on month to month. I haven’t seen inside pictures. The other unit the lease expires in December - 1st year the tenant has been there.

Would you bump them up slowly year over year or do a market adjustment to the current rent rates?

@Alex Heidenreich cash flow at current rents would be $155/month, so less than $100/door. But at market rate would be $900/month total, $450/door.

Normally I wouldn’t consider a property under $200/door. But the potential here is really enticing. But I just don’t know if it’s a smart move to buy for the future, not for the now.

Total return is what investing is all about.  If you see an opportunity to increase the investment's value in terms of higher rents, seize it by all means.   

@Sarah McCluskey it sounds like a good deal to me with those lease terms. You will have the opportunity to present them with new lease options right away. The way we handle rent increases with current tenants (if you decide you want the tenants to stay) is to offer them a few different options at varying levels of rent increase or discount. Such as month-to-month (highest rent increase), 1 year (medium rent increase), and 2 year (lowest rent increase). This gives them choices and allows you to get rent to where it belongs. Just make sure they are good tenants before you lock them in long term. 

Absolutely yes.....

BUT......one factor that many people overlook when they evaluate "market rate"..... is the unit REALLY going to pull that market rate in its current condition? LOTS of units that are under market rate haven't been updated or rehabbed in a LONG time...... so to really justify getting the market rate in the area, you often have to put in some $$ up front to get them into  the real condition where people will pay the market rate.... its more than bedroom, bath room, sq footage comparisons when you determine "market rate" for your area

So if you have a tenant that is under market rate and you jump up to the going rate and the "market rate"  will get them a nicer place with new paint, flooring, fixtures etc and your unit hasn't been touched in years, they will likely leave to a nicer place that costs the same

@Theresa Harris the cash flow would be $155 total for the duplex now, but ideally $900 total for the duplex once the rents were at in line with the market.

The rent for each unit is currently $850 and $900 per month, but based on the area, should be $1300/ month per unit. I know it’s not realistic to bump them up that much overnight, so I’m trying to figure out if the future potential is worth the initial low cash on cash return and low cash flow.

@Ned J. Thank you for sharing! Definitely a valid point. I can only see one unit right now because it was listed for rent a year ago. It’s in line with the quality of the other units in the area going for much higher.

The curve ball could be the unit where the tenant has been there 8 years. I’m sure it would need some updating.

@Sarah McCluskey   Yes, I would offer based on current numbers, not pro forma.  That way the seller is not getting all the benefit of your hard, upcoming work to reduce expenses and increase rents.

@Mark H. Porter makes sense. The tricky part here is this was a direct mail campaign and they weren't really looking to sell, so not motivated at all. They'd part with it for about $10k under what it would go for on the MLS, but not much more than that. So, I have to decide if it's worth it At the current price for the future cash flow vs. the current cash flow.

In the deals I've done I look at today's cash flow as well as tomorrow's appreciation. Based on my goals I'm targeting immediate cash flow so that I don't have to feed an investment each month out of pocket. While many investors don't look at Internal Rate of Return I believe it's a great way to understand long term value of a residential or commercial investment. I leverage IRR to measure against what Gary Keller calls Safe, Healthy or Wealthy Money Goals in Millionaire Real Estate Investor. While you didn't mention any of the non-quantitative qualities of the property, I would highly recommend you also look at location and whether the property is in the path of progress. This view will allow you to assess the "quality" of the cash flows you are receiving and whether the location is trending up or down.

You should always value a property based on market rents, not what they are currently paying. Current rents could be lower or even higher than what you could rerent it for. Based on what you shared, it looks like a good deal. 

@Sarah McCluskey I’d assume both units need a lot of work. Where is the property located? Is it in a state where it would be difficult to end the current tenant’s leases? At face value I’d say it’s a good opportunity.

Originally posted by @Sarah McCluskey :

@Jonathan Hulen

One unit from what I can see in last years pictures just needs some fresh paint and maybe updated floors. The other unit I have no visibility to yet, so it may need more work. I am in southeastern wisconsin.

As long as you can legally end their leases by providing notice, I would say it’s worth it. Check your local laws.  

@Sarah McCluskey

I take those deals. The hurdle is biting the bullet on the increases and timing. This is how I talked myself into it years ago. I told myself, I am going to charge market rent and if they stay great, if they leave great. Some stayed and some left. This way you don’t have to feel you are kicking someone out and they make that choice.

Also, you are buying an asset for what it could be, not how it is run right now. Everything I buy is based on a pretty conservative pro forma. Then I attempt to get my rents and expenses there. Don’t fall into the trap of keeping the status quo of what is there now.

Sometimes you just have to eat some costs (opportunity costs in your case) in the beginning to make what you want in the end. Make sure you have reserves and can get it there and a plan for when you will make the increases. In your case I would do them at separate times.