If there's cash flow, what can go wrong?

Question

I know, a lot people are gonna say--a lot of things...:)

I have been reading people's stories here and tried to understand how people would get burned on rental property investing when market crashed.

--property was never cash flowing.

--Maybe property was cash flowing, then you refinanced, in the end you cannot afford it and the property becoming negative cash flowing?

--lost a job?( but if your property was cash flowing and you did have cash reserve for repairs, you will be ok, no?)

-- property was once cash flowing, then tenants sued, and your insurance was not enough to cover?

--location from B- and become D, cannot fill the vacancy?

I will be interested in your opinion on this. This can also help us newbies to know what needs to be avoid and better managed in terms of financial risks.

Thanks.

Jay Orlauski · Answer

"let me count the ways....."    the biggest enemy to cash flow is lack of cash flow ( obviously)  - but just because a property is  positive cashflow right now doesn't mean it will always be. For example the biggest factor in determining cash flow is vacancy  - 100% vacancy equals no cash flow. So if your place is not in a desirable area or has too much deferred maintenance, this can be a real cash flow killer if you cannot get it rented out if a tenant leaves. There may be so much cleanup to do that it can eat up a whole years worth of profit.  Especially if you have to replace major items like carpet, A/C units, or appliances. The same thing can happen if you have major expenses even while the tenant is still living there - especially if it causes them to stop paying rent and forcing you into an eviction which will eat even more of your profits. The smaller your cash flow is to start with , the bigger the risk of eating into it with major repairs -most investors apply the 50% rule that says your repairs and maintenance will equal 50% or your rental income.

This is just one of the many ways things can go wrong. Another issues is that If your in an ARM ( adjustable rate mortgage)  and the interest rate goes up, you can find yourself upside down on cash flow, forcing you to raise rents and possible price yourself out of the market.

Your insurance can go up and increasing your holding costs of the property - and if you made any major improvements , you may end up with a higher tax bill also. All these little things can nickel and dime your cash flow to death.

Personally, this is why I prefer multi-family units vs SFR's because if you have only have one tenant and they stop paying rent or pay late, then you are responsible for the entire mortgage on your own. With multi-family units,  you have a little more leeway when it comes to slow payers , as you will have other tenant's rents to help cover the non paying tenant. Doesn't mean you are guaranteed cash flow every month - but it certainly helps cover your expenses in the case of vacancies or non payers.

I'm interested in hearing other investors take on this too.. ....

Jon Holdman · Answer

New investors often believe the "cash flow = rent - PITI" myth.   They bought properties during the bubble that barely cash flowed with that "phony cash flow" forumula.  Or were negative.  They bought with 100% financing and tricky loans.  They expected prices to rise, to be able to refi and just hang on, even with negative cash flow, and sell for a big pay day.  When prices crashed, they were stuck far under water with a cash flow negative property.

Linda L. · Answer

A few people I know who are successfully utilizing the ARM have two things in common.

1. They normally plan and can acutally pay it off before the end of ARM.

2. They have no problem to refinance in the end of term. Even if they cannot refinance, they do have the cash to pay it off right then.

Michaela G. · Answer

Act of god, that's not specifically covered by your insurance? A flood in a no-flood zone? A big tree coming down?

Now you're stuck with expenses to fix the property with cash

Linda L. · Answer

So if the cash flow is real cash flow based on 50% rule and the mortgage is fixed 15-30 years, even if the market crash in the middle, the rent decreases.

As long as you don't need to get out for cash, how would the market crash made you be totally out of game? What other factors can go wrong if the expense is well budgeted at 50% rule and mortgage is fixed?

Roy N. · Answer

Ali,

I know the mortgage scene is much different up here and there is more of a propensity to avoid carrying interest, but we've always used variable rate mortgages with great success.

We use a variable rate capped product on our residential properties (functions similar to an ARM) and set our payment based on the "worst case" (ie. if we ended-up paying at the capped rate).   This affords us an accelerated paydown of principle and, since we did our pre-purchase analysis using the "worst case", there is still enough cash-flow to meet our requirements.

Ali Boone · Answer

A lot of people had adjustable mortgages, so when the mortgage finally adjusted it caused the monthly payment to negate the cash flow. Moral of that story- get fixed loans.

Michael Seeker · Answer

This would be the only thing I'd be worried about if you invest properly.  Economic downturn actually improved the rental market as many people lost their homes and could not buy new ones.

If there's cash flow, what can go wrong?

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