Solving the negative cash flow issue with LA rentals

Multi-Family and Apartment Investing
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Solving the negative cash flow issue with LA rentals

Account Closed
Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes

So you are told its impossible to cash flow in LA. Actually you can, it just requires slightly more cash down. You can also try lowering expenses, although that might barely make a difference.

If data from Zillow is correct, current median listing price for a home in LA is about $749,000. You can almost forget about a nothing down purchase... with a 20% down payment, 4.7% 30-year conventional mortgage rate and financing the principal of: $599,200, your monthly mortgage payment would equal: $3108. 

But median LA rent for a home appears to be about $3500. We already see some problems here. To break even, you would have to keep total expenses at 11.21% or $392 per month -- thats a long ways from 50% suggested by the 50% rule. Using estimated expenses of 45%, the result is a monthly negative cash flow of $1,182.68. 

So owner would have to incur an additional out of pocket expense of $14,192.13 per year, just to maintain property and hoping property appreciates in value in excess of this amount just to soften the hit.

Median LA Listing Price           $749,000
20% Down Payment           $149,800
Loan Principal           $599,200
Mortgage Rate                 4.70%
Term (months)                    360
Mortgage Payment                $3,108
Median LA Rent                $3,500
Avg Expense 45%               $1,575
Net Operating Income               $1,925
Gross Income Per Year             $42,000
Cap Rate            3.0841%
Cash Flow        $(1,182.68)

In order to break even, and we aren't even talking positive cash flow yet, you would need a down payment of about 50.45% of the property value to significantly reduce loan principal. 

Example: holding all else constant,  50.45% of the $749,000 in cash for the down would reduce loan principal to about $371,165 which then enables property owner to break even. 


Median LA Listing Price            $749,000
50.45% Down Payment            $377,835
Loan Principal            $371,165
Mortgage Rate                 4.70%
Term (months)                    360
Mortgage Payment               $1,925
Median LA Rent               $3,500
Avg Expense 45%               $1,575
Net Operating Income               $1,925
Gross Income Per Year            $42,000
Cap Rate            3.0841%
Cash Flow               $ - 0

Is a 50% down payment weird or normal in your market? 

So if you thinking about scooping up a rental in LA, the real question is, how much down you planning to play with?

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Thomas S.
Member since 2016 · 13k+ posts · 12k+ votes
9y

Only the most inexperienced of investors would invest on the assumption that the equity (DP) in a property increases cash flow.

True cash flow calculations can only be made based on a 100% financed property. That would be taking into consideration the prevailing mortgage interest rates to calculate cash flow. Once a investors throws cash into the deal that equity cost is calculated based on a assumed opportunity value of 10%. This is obviously much higher than prevailing costs of financing resulting in DP (equity) actually reducing cash flow on a property not increasing it. Equity is a extremely expensive way to purchase artificial cash flow.

Any investment property that can not show true positive cash flow with 100% financing can never have true positive cash flow. Equity will only make cash flow numbers worse assuming a investor actually understands and appreciates the value of money. 

For every 100K in equity it reduces any true cash flow on the property by $866/month.

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  • Diane G.
    CA · Member since 2016 · 1k+ posts · 1k+ votes
    9y
    That is no news to anyone on the coast.... Within like 5 minutes of walking distance, someone bought a SFH for $2.5 million just to rent $6600 a month... another bought for $1.8m just to rent $4500 a month.... I hope they are all 100% cash down... if they finance the purchase, they would be looking at $3000 a month loss easy... That is just the reality of Bay Area...
    4Reply
  • Diane G.
    CA · Member since 2016 · 1k+ posts · 1k+ votes
    9y
    Within 5 minutes of where I live....
    1Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    9y

    Only the most inexperienced of investors would invest on the assumption that the equity (DP) in a property increases cash flow.

    True cash flow calculations can only be made based on a 100% financed property. That would be taking into consideration the prevailing mortgage interest rates to calculate cash flow. Once a investors throws cash into the deal that equity cost is calculated based on a assumed opportunity value of 10%. This is obviously much higher than prevailing costs of financing resulting in DP (equity) actually reducing cash flow on a property not increasing it. Equity is a extremely expensive way to purchase artificial cash flow.

    Any investment property that can not show true positive cash flow with 100% financing can never have true positive cash flow. Equity will only make cash flow numbers worse assuming a investor actually understands and appreciates the value of money. 

    For every 100K in equity it reduces any true cash flow on the property by $866/month.

    5Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y

    Median prices in Sunnyvale ($1.5 mil) varies from median prices in LA (749K). 

    But, median rent in Sunnyvale is about $3,950 and median rent in LA is $3,500. 

    For the cash flow investor, LA would be the $en$ible buy. At what rate are property prices growing in Sunnyvale per year?

    The scenario you mentioned is the definition of bad math. At $2.5mil, you would need to put down 72% just to break even. 

    Property values would have to be growing at an astronomical rate to make sense or it would be a sunk investment. 

    It also suggest that is a market not meant for rentals... this is starting to make sense why the authorities are having so much issues with airBNB. By the way, the $6,600 rent you mentioned is almost twice the market median.

    Price / Market Value $2,500,000
    72% Down Payment $1,800,090
    28 % Loan Principal $699,910
    Mortgage Rate 4.70%
    Term (months) 360
    Mortgage Payment $3,630
    Rent $6,600.00
    Avg Expense 45% $2,970.00
    Net Operating Income $3,630.00
    Gross Income Per Year $79,200.00
    Cap Rate 1.7424%
    Cash Flow $ (0.00)
    1Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y

    @Thomas S. This isn't clear if you are trying to raise an arbitrary argument here or if this is just your personal theory... capital structure is not something you walk into a store and buy off the shelf and apply uniformly to every company. A company or investor may use equity, debt or both to finance any asset however he sees fit and based on their specific situation.

    It is a mathematical fact that if you are buying a rental property in any city where the monthly mortgage payment exceeds monthly rental income, or where mortgage payments along with monthly expenses exceed monthly rent, if any of those scenario applies, a down payment would be only other material method to avoid a negative cash flow situation.

    You let the investor worry about his gamble on the market going up.. thats not your problem. But what the investor wants to know is what the yearly out of pocket expense is likely to be if property doesnt cash flow to fund total expenses and debt service for duration of whatever his holding period is.

    LA for instance regardless of its cap rate will always have a demand for rental housing... and someone does have to invest there... how or why it makes sense to them is really their issue. 100% financing is not available in every market.

    3Reply
  • Justin Fox
    Software Developer · Vidor, TX · Member since 2015 · 922 posts · 639 votes
    9y

    @Account Closed

    What if the properties in that area historically get ~100% appreciation every decade?

    Cost/Gains After 10 years:
    149,800 (DP)
    141,921.60 (carrying cost (-1182.68/mo))
    112,984.42 (Total Equity)

    Value after 10 years: 1,489,000
    Balance: 486,215.86
    972,430 in equity.

    Walk out of closing with $680,708.40 ($5,672.57/mo CF) after paying yourself back the total: DP and carrying cost.

    This is a simplification also.  Could have decreases in out of pocket expense due to rent increases.  Also a little more cost upfront and at the end for closing.

    0Reply
  • Manolo D.
    Contractor · Los Angeles, CA · Member since 2015 · 4k+ posts · 1k+ votes
    9y
    This is easy to solve, and I strongly believe that it will be true to all properties in CA. Put 100% down, and it surely WILL cash flow. Now, for the true test of cash flow, you need to assume you finance it 100%! including closing cosrs and everything before they give you the keys. 3.5, 5, 10, 20% DP is cheating! With that said, many will find it true also in a federal level that 50% of their "cash flow positive" is not actually cash flowing.
    0Reply
  • Michael Lucero
    Rental Property Investor · Pasadena, CA · Member since 2016 · 164 posts · 149 votes
    9y

    I'm sorry, am I missing something, this seems to be beyond obvious. The higher your down payment, the higher your chance of cash flowing becomes, however on the flip side, your ROI or COC goes way down to a point where you are hardly making a return. Sure in LA you can get a property for 100% cash at like $1m and rent it for 3.5k and cash flow but even with no other expenses you are at a 3.5% return on invested capital. After taxes, repairs, maintenance, etc you are guna be much lower. Unless of course you are trying to play the speculative/luck appreciation game, I don't see the point, go buy treasury/muni bills.

    3Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y
    Originally posted by @Justin Fox:

    @Account Closed

    What if the properties in that area historically get ~100% appreciation every decade?

    Cost/Gains After 10 years:
    149,800 (DP)
    141,921.60 (carrying cost (-1182.68/mo))
    112,984.42 (Total Equity)

    Value after 10 years: 1,489,000
    Balance: 486,215.86
    972,430 in equity.

    Walk out of closing with $680,708.40 ($5,672.57/mo CF) after paying yourself back the total: DP and carrying cost.

    This is a simplification also.  Could have decreases in out of pocket expense due to rent increases.  Also a little more cost upfront and at the end for closing.

     Interesting.. your numbers seems very close to the facts. The long term growth in property prices in the LA Long Beach metro is about 7.14% (1976 to 2016, Federal Reserve); so using the rule of 72, the price would or should double in 10 years.

    Also the 45% expense estimate is in some ways high as there are companies able to achieve 38 to 40% and rent would or should be expected to grow at at least 3% per year in LA even with rent controls to keep pace with inflation.

    It is sort of the nature of the LA market and some of the other markets where you essentially go long, as opposed markets like Atlanta or St. Louis markets that produces a positive monthly cash flow upfront.

    0Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y
    Originally posted by @Michael Lucero:

    I'm sorry, am I missing something, this seems to be beyond obvious. The higher your down payment, the higher your chance of cash flowing becomes, however on the flip side, your ROI or COC goes way down to a point where you are hardly making a return. Sure in LA you can get a property for 100% cash at like $1m and rent it for 3.5k and cash flow but even with no other expenses you are at a 3.5% return on invested capital. After taxes, repairs, maintenance, etc you are guna be much lower. Unless of course you are trying to play the speculative/luck appreciation game, I don't see the point, go buy treasury/muni bills.

    What is clearly obvious is you missed the point... don't talk obvious, talk specifics... and why else would any sane person invest in a rental market with a negative cash flow other than speculation on value increase? If 30 year treasuries is 3% and inflation is 3%, perhaps thats just your thing. 

    0Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y
    Originally posted by @Manolo D.:

    This is easy to solve, and I strongly believe that it will be true to all properties in CA. Put 100% down, and it surely WILL cash flow. Now, for the true test of cash flow, you need to assume you finance it 100%! including closing cosrs and everything before they give you the keys. 3.5, 5, 10, 20% DP is cheating! With that said, many will find it true also in a federal level that 50% of their "cash flow positive" is not actually cash flowing.

    Sure you buy a property 100% cash and chances are you have no debt service...that would be obviously obvious. A different case from an investor looking to invest in LA and wanting to know specifically exact cash debt mix to achieve a specific positive cash flow or income per month on a property.

    0Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    9y
    Originally posted by @Account Closed:
    Originally posted by @Justin Fox:

    @Account Closed

    What if the properties in that area historically get ~100% appreciation every decade?

    Cost/Gains After 10 years:
    149,800 (DP)
    141,921.60 (carrying cost (-1182.68/mo))
    112,984.42 (Total Equity)

    Value after 10 years: 1,489,000
    Balance: 486,215.86
    972,430 in equity.

    Walk out of closing with $680,708.40 ($5,672.57/mo CF) after paying yourself back the total: DP and carrying cost.

    This is a simplification also.  Could have decreases in out of pocket expense due to rent increases.  Also a little more cost upfront and at the end for closing.

     Interesting.. your numbers seems very close to the facts. The long term growth in property prices in the LA Long Beach metro is about 7.14% (1976 to 2016, Federal Reserve); so using the rule of 72, the price would or should double in 10 years.

    Also the 45% expense estimate is in some ways high as there are companies able to achieve 38 to 40% and rent would or should be expected to grow at at least 3% per year in LA even with rent controls to keep pace with inflation.

    It is sort of the nature of the LA market and some of the other markets where you essentially go long, as opposed markets like Atlanta or St. Louis markets that produces a positive monthly cash flow upfront.

    Yep ... 45% (or 50% rule) definitely falls apart at high or super low rent rates ... expenses just do not scale linearly with rents, which is why I never cared much for that rule of thumb. Also, mentioned, there is market appreciation in both prices and rents, which yes does on average double every ~10 years in and around LA ... who knows what it could be next year or the year after, but over a long hold period this is the average if the long term (going back 40+ years) holds into the future, and I don't see any major fundamental shift in the supply and demand dynamics to suggest it would.  Also, not mentioned is that there is forced appreciation, tax savings, and amortization going on here (and in every market) that contribute to the bottom line. Finally, the amount of work per dollar of profit, with fewer high value assets with a strong tenant base and strong rental demand is a consideration. So, not saying it is necessarily a good deal or bad deal, only that there are many, many things to be considered beyond just day one cash flow and that investors can and should tailor their strategy with ALL of these considerations in mind.

    3Reply
  • Ray Harrell
    Investor · Chicago, IL · Member since 2016 · 1k+ posts · 930 votes
    9y

    But why pay $1.5 million cash for a house to cash flow $3,000 per month? It would take 500 months just to recoup your investment!!! Makes no sense to me!

    0Reply
  • Jorge Contreras
    Victorville, CA · Member since 2017 · 22 posts · 20 votes
    9y
    Originally posted by @Account Closed:
    Originally posted by @Michael Lucero:

    I'm sorry, am I missing something, this seems to be beyond obvious. The higher your down payment, the higher your chance of cash flowing becomes, however on the flip side, your ROI or COC goes way down to a point where you are hardly making a return. Sure in LA you can get a property for 100% cash at like $1m and rent it for 3.5k and cash flow but even with no other expenses you are at a 3.5% return on invested capital. After taxes, repairs, maintenance, etc you are guna be much lower. Unless of course you are trying to play the speculative/luck appreciation game, I don't see the point, go buy treasury/muni bills.

    What is clearly obvious is you missed the point... don't talk obvious, talk specifics... and why else would any sane person invest in a rental market with a negative cash flow other than speculation on value increase? If 30 year treasuries is 3% and inflation is 3%, perhaps thats just your thing. 

     It was said already, yes you can increase your down payment in order to make the cash flow but from a cash on cash perspective it makes no sense to do so, as the returns will make it a bad investment unless it does appreciate in value and can sell down the road for profit but then your not really investing for cash flow at that point but rather appreciation in which then can you manage the property until it does?

    0Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y
    Originally posted by @Ray Harrell:

    But why pay $1.5 million cash for a house to cash flow $3,000 per month? It would take 500 months just to recoup your investment!!! Makes no sense to me!

     You can ask @Diane G. to explain the rationale of investors in her area. I think she said it was the norm to pay $2.5mil for a property that only rents for $6600 per month. Other than expecting growth in value to make the difference, not sure how else to justify it... the down payment can alter the results in all sorts of direction...

    0Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y
    Originally posted by @David Faulkner:
    ...So, not saying it is necessarily a good deal or bad deal, only that there are many, many things to be considered beyond just day one cash flow and that investors can and should tailor their strategy with ALL of these considerations in mind....

    To some investors the question is this: if the long term growth rate in LA property values is 7.14% per year, is that worth the pain of a 50% down payment on a $750,000 property just to achieve a 3% cap rate? Is that really the best use of the funds? 

    Certain nooks in CA like Pittsburg or Richmond, if zillow's info in correct, have apparently grown year on year by an average of about 19% for each of the last 5 years...probably not a sustainable growth rate for 10 years but that would be the sort of growth rate per year that would justify 50 or 70 % down payments. 

    Cap rates in some areas is below 2%. It has to make sense.

    0Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    9y
    Originally posted by @Account Closed:
    Originally posted by @David Faulkner:
    ...So, not saying it is necessarily a good deal or bad deal, only that there are many, many things to be considered beyond just day one cash flow and that investors can and should tailor their strategy with ALL of these considerations in mind....

    To some investors the question is this: if the long term growth rate in LA property values is 7.14% per year, is that worth the pain of a 50% down payment on a $750,000 property just to achieve a 3% cap rate? Is that really the best use of the funds? 

    Certain nooks in CA like Pittsburg or Richmond, if zillow's info in correct, have apparently grown year on year by an average of about 19% for each of the last 5 years...probably not a sustainable growth rate for 10 years but that would be the sort of growth rate per year that would justify 50 or 70 % down payments. 

    Cap rates in some areas is below 2%. It has to make sense.

    I think it sounds like you missed my point entirely ... perhaps maybe, just maybe, there are properties out there that an experienced investor can find and create deals where they don't need to put 50% down payment and pay $750,00 price to get cash flow. Maybe a skilled investor can do better than the average property purchased at the average retail price. Maybe it is possible for a skilled investor to purchase a property in a market with a 2% market CAP rate and raise the NOI to make a huge profit through forced appreciation, where the low CAP rate actually helps them in this case ($1/(2%) = $50 forced appreciation for every dollar increase in NOI!). Maybe a skilled investor knows how to analyze and exploit ALL of the profit centers of REI ... but in order to do this they would first need to take off the cash flow blinders. If the only tool you have is a hammer, then every problem looks like a nail. Maybe, just maybe it is possible ... nah, never mind, we're all just a bunch of degenerate gamblers that just got really, really lucky. LOL.

    0Reply
  • Andrey Y.
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    9y
    Originally posted by @Account Closed:

    So you are told its impossible to cash flow in LA. Actually you can, it just requires slightly more cash down. You can also try lowering expenses, although that might barely make a difference.

    If data from Zillow is correct, current median listing price for a home in LA is about $749,000. You can almost forget about a nothing down purchase... with a 20% down payment, 4.7% 30-year conventional mortgage rate and financing the principal of: $599,200, your monthly mortgage payment would equal: $3108. 

    But median LA rent for a home appears to be about $3500. We already see some problems here. To break even, you would have to keep total expenses at 11.21% or $392 per month -- thats a long ways from 50% suggested by the 50% rule. Using estimated expenses of 45%, the result is a monthly negative cash flow of $1,182.68. 

    So owner would have to incur an additional out of pocket expense of $14,192.13 per year, just to maintain property and hoping property appreciates in value in excess of this amount just to soften the hit.

    Median LA Listing Price           $749,000
    20% Down Payment           $149,800
    Loan Principal           $599,200
    Mortgage Rate                 4.70%
    Term (months)                    360
    Mortgage Payment                $3,108
    Median LA Rent                $3,500
    Avg Expense 45%               $1,575
    Net Operating Income               $1,925
    Gross Income Per Year             $42,000
    Cap Rate            3.0841%
    Cash Flow        $(1,182.68)

    In order to break even, and we aren't even talking positive cash flow yet, you would need a down payment of about 50.45% of the property value to significantly reduce loan principal. 

    Example: holding all else constant,  50.45% of the $749,000 in cash for the down would reduce loan principal to about $371,165 which then enables property owner to break even. 


    Median LA Listing Price            $749,000
    50.45% Down Payment            $377,835
    Loan Principal            $371,165
    Mortgage Rate                 4.70%
    Term (months)                    360
    Mortgage Payment               $1,925
    Median LA Rent               $3,500
    Avg Expense 45%               $1,575
    Net Operating Income               $1,925
    Gross Income Per Year            $42,000
    Cap Rate            3.0841%
    Cash Flow               $ - 0

    Is a 50% down payment weird or normal in your market? 

    So if you thinking about scooping up a rental in LA, the real question is, how much down you planning to play with?

    Interesting. I'd like you to do a similar analysis of your backyards, Brooklyn and Manhattan.

    0Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y
    Originally posted by @David Faulkner:
    Originally posted by @Account Closed:

    Interesting... the more you try to be civil... the more you have a loose nut try to start an unnecessary argument.

    If you are trying to brag about having some legendary imaginary investment skillz with a big Z to me, you barking up the wrong tree chuck... and if you dont have anything relevant or positive to add the discussion, find somewhere else to rant.

    Most multi family cash flow investors buy properties with cash or use debt from a lender for most transactions... so if you are referring to any other non main stream, private money route or pooling of investor funds as some sort of rocket science then feel free to give yourself a pat on the back... feel better now!

    The mere fact that you have to resolve to unusual or abnormal means to achieve normal results tells you there may be something fundamentally wrong. 

    Market rent is market rent -- has nothing to do with your "skillz". Market rent ultimately determines cap rate if expenses aligns with market norms. If you need a hammer try Lowes or HomeDepot.

    0Reply
  • Andrey Y.
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    9y
    Originally posted by @Account Closed:
    Originally posted by @David Faulkner:
    ...So, not saying it is necessarily a good deal or bad deal, only that there are many, many things to be considered beyond just day one cash flow and that investors can and should tailor their strategy with ALL of these considerations in mind....

    To some investors the question is this: if the long term growth rate in LA property values is 7.14% per year, is that worth the pain of a 50% down payment on a $750,000 property just to achieve a 3% cap rate? Is that really the best use of the funds? 

    Certain nooks in CA like Pittsburg or Richmond, if zillow's info in correct, have apparently grown year on year by an average of about 19% for each of the last 5 years...probably not a sustainable growth rate for 10 years but that would be the sort of growth rate per year that would justify 50 or 70 % down payments. 

    Cap rates in some areas is below 2%. It has to make sense.

     What doesn't make sense to you? LA, SF, SD, Bay Area has the best returns (=profit) of out all USA markets (since 2000). This means that, you could not get a better return if you invested ANYWHERE else in the US.

    Return = cash flow + appreciation

    You just cannot argue with facts. There is no where in the Midwest, South, etc. that could historically or now get you a better return than the coastal California markets I just mentioned. Just because you cannot afford the investment, doesn't mean its a bad investment. The facts show otherwise.

    @Matt R.@Account Closed@Account Closed

    @Account ClosedThese guys could perhaps add to the discussion :)

    I think its important to learn the definition of profit and income in business.

    0Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y
    Originally posted by @Andrey Y.:

    Interesting. I'd like you to do a similar analysis of your backyards, Brooklyn and Manhattan.

     Sorry Andrey, but this just sounds wrong and possibly illegal.

    0Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y
    Originally posted by @Andrey Y.:
    Originally posted by @Account Closed:

    If its all about 7% per year on funds, heck there are bonds paying close to that with lower risk. What I can afford you can speculate about all you want but last I checked... I didn't enact current rent controls that many of the investors there are griping about. And rent controls get enacted because residents there, have no issues right?

    Some investors want a positive monthly cash flow per month not 10 years from now. Some investors obviously just need to park the funds somewhere and get it out whenever... different motives.

    If you are simply talking about which cities in the country have had highest average returns per year last 30 or 40 years thats just data... but there is a difference between the population in California and the population in Maine. You can't expect property prices to be growing at the same rate in both areas.

    By the way.. if you review the link below, and if that applies to most areas in California, then we are only talking about 28% or so of the transactions being cash transactions. So there might be 69-70% of transactions using debt.

    Introducing any sort of debt into the equation just throws off the numbers in some cases and doesn't make deal as profitable. Any multi family cash flow investor who utilizes leverage in any or majority of deals and expects or is used to positive cash flow per unit monthly, will always frown at some of the California numbers. This doesn't mean Cali doesn't grow at 7% per year.

    And so if we are using the: Cash Flow + Appreciation view

    Using a basic $750,000 property in LA, with debt in the mix, Cash Flow may of be negative, costing investor money just to maintain the property. 

    If only making a 20% down by the way (which would be unheard of for anyone with cash flow motives in LA for instance), the investor would have to spend almost $15,000 out of pocket funds just to keep property by each year.  

    Negative cash flow to the tune of $15,000 per year for 10 years is a gamble. The market doesn't guarantee the 7% per year. Market could tank just when you are about to exit so none of this is guaranteed.

    The play (or shall we say pray), for many investors in the market there is appreciation - especially when using leverage.

    http://www.sfchronicle.com/business/networth/artic...

    0Reply
  • Lesley Resnick
    Real Estate Agent · Jacksonville, FL · Member since 2015 · 1k+ posts · 1k+ votes
    9y

    There seems to be a visceral disagreement over gateway (NY,Sf,LA, Miami, etc)  cities or not.  Typically it is the people who live in these places who feel they must defend their city.  When it comes to investing who cares what city you live in and invest, It is about the numbers.  If you did not live there, would you still invest there? If you did not already own it, would you buy it today? 

    The gateway cities are among the coolest to live in, but not necessarily to invest.  There are certain themes that are reoccurring.  The notion that gateway cities always have the best appreciation.  It is not a fact, sometimes they do.  They are more expensive and actuals dollars will be larger.  There are time periods for every market that out perform others and to just make a blanket stament is not a fair assessment.  

    On the non institutional side under 1000 doors, money is not flowing into the gateway cities.  Currently it is net a outflow.

     Institutional and foreign money is still flowing into gateway cities, because of the scale, in NYC, you could spend 500m with out effecting the market.

    My persoanl goal is cashflow and cash preservation.  It feeds the machine and allows me to fund my next deal.  There are a million approaches and methods to make money in RE.  If it is right for the individual investor, who is to say otherwise.  The fact is no one will know who was right until it is too late.   

    2Reply
  • Alexander Monnin
    OH · Member since 2017 · 45 posts · 38 votes
    9y

    Typically when I do internal rate of return calculations for properties in high appreciating areas, they have higher returns with LESS down payment despite being more cash flow negative.  This is because financing enhances the returns through appreciation.  In terms of only appreciation, a 7% market appreciation gives a 7% return IF the property is bought with 100% cash.  If it is financed, the 7% appreciation can give a return a lot higher than 7%.

    2Reply
  • Account Closed
    OP
    Professional · Brooklyn, NY · Member since 2017 · 624 posts · 147 votes
    9y
    Originally posted by @Alexander Monnin:

    Typically when I do internal rate of return calculations for properties in high appreciating areas, they have higher returns with LESS down payment despite being more cash flow negative.

    The IRR, has its issues -- especially when talking about negative cash flow situations that may generate multiple IRRs but that is digressing from the point.

    The purely cash flow oriented investor, typically invest to generate passive positive income -- usually monthly. They don't want to look at investments with negative monthly cash flow, regardless of actual cumulative returns 10 years from now.  

    If rent in LA is $3500 a month and half of that is expenses, that means I only have $1750 to service the mortgage. But mortgage payment itself is almost $3800 at a 4.7% rate. So instead of generating a positive passive income from this property, I would be generating a passive monthly expense of almost $2100 per month. 

    One thing you don't have to explain too hard to some investors is what income is and what expense is. A $2100 monthly expense for 10 years on a property or for however long the holding period is, is just not something they are looking at. It has nothing to do with whether they have the cash to spend. The philosophy is to let leverage do its job.

    It doesn't make LA a bad market, someone still has to live there. It just means an investor whose investment objective is generating positive passive monthly income, may better achieve that goal in say Detroit or Baltimore or may have to look into bonds or a dividend paying stock, as opposed to crossing your fingers and waiting on appreciation while getting hit with monthly cash outflow throughout the holding period.

    So if the number makes sense considerably in the long term... then as some way to avoid walking away from the market completely, the investor may then have to figure out just how much cash is needed for a down payment, to finance a lower principal balance, where they just break even and dont to incur a monthly cash outflow as previously discussed.

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