Refinance from negative cash flow to positive cash flow

15 Replies

Hello BP Community!

I have a rental property in Philadelphia which within the past year I just refinanced to reduce the term of  the loan from 25 years to 15 years.  This property was originally purchased as my primary residence and then became a Single Family Home rental.  In the recent months I have been looking to purchase my next single family home rental and have been analyzing other deals in the area.  In doing so, I decided to analyze my current property, which I have never done, being that it was originally purchased as my primary residence.  In doing so, I discovered that this property (with the refinance) now has a negative cash flow of about -$1,200/year.  I am debating what my next step should be.

1. Sell the property and purchase another Single Family Home rental with potential positive cash flow.

2. Refinance (although the last refinance happened about 1 year ago) to a longer term mortgage to bring it back to a positive cash flow property.

3. Nothing.....keep the shorter term mortgage and enjoy the positive cash flow once the mortgage is paid off.

Thanks in advance for everyones input/advice, and I would be happy to answer any questions that might help in this decision.

Originally posted by @Daniel Kent :

Hello BP Community!

I have a rental property in Philadelphia which within the past year I just refinanced to reduce the term of  the loan from 25 years to 15 years.  This property was originally purchased as my primary residence and then became a Single Family Home rental.  In the recent months I have been looking to purchase my next single family home rental and have been analyzing other deals in the area.  In doing so, I decided to analyze my current property, which I have never done, being that it was originally purchased as my primary residence.  In doing so, I discovered that this property (with the refinance) now has a negative cash flow of about -$1,200/year.  I am debating what my next step should be.

1. Sell the property and purchase another Single Family Home rental with potential positive cash flow.

2. Refinance (although the last refinance happened about 1 year ago) to a longer term mortgage to bring it back to a positive cash flow property.

3. Nothing.....keep the shorter term mortgage and enjoy the positive cash flow once the mortgage is paid off.

Thanks in advance for everyones input/advice, and I would be happy to answer any questions that might help in this decision.

 I would personally never keep the property and loose 18k while waiting for it to cash flow. And is that 1200 a year including maintenance and management? Either way I would sell or 1031 exchange it. How long ago was it your primary residence? If you lived there for 2 years out of the last 5 you will be excluded out of paying capital gains taxes if you make a profit when selling it. 

I agree with Lana.  The only thing that saved me with a negative cash flowing property is appreciation, but that took several years.  Best to move on and find an investment that pays better right from the start.

Fully analyze the deal and make sure its' a deal you want, if it's not a great deal then sell and reapply the funds to something more efficient.

if it's a good deal with poor finance structure then just refinance.

Sell it and save your self a ton of lost income. Paying down a rental property is creating dead equity that is costing you thousands in lost opportunity value monthly.

@Daniel Kent

Here is an easy calculation for you.

Let's say your original mortgage was $100k.

Since you have it on a 15 year fixed rate mortgage, take the $100k and divide it by 15 years.

$100k / 15 years = $6,667 per year.

If you include the fact that your Mortgage goes away in 15 years, then you are effectively building up Equity on average by $6,667 per year.

If you add your negative cash flow to your positive equity growth via Mortgage Reduction, you get NEGATIVE $1,200 PLUS $6,667 = $5,467 POSITIVE Per year.

If your Property is in a solid area where the value of your property will continue to be at or above the current value by the 15th year, you are doing fine to me.

I've been investing for 20 years in Brooklyn, NY. I get plenty of other advantages other than cash flow.

You have several ways of making money in RE.

1) Cash Flow

2) Mortgage Balance Reduction

3) Appreciation and

4) Tax Deductions

5) Leverage your Equity

While you don't have 1) Cash Flow, the others will help out over time.

You WILL get 2) Mortgage Balance Reduction if you locked in a 15 year fixed rate mortgage

You MAY get 3) Appreciation, but that's not guaranteed, however, you don't need to depend on this since the Mortgage Balance Reduction could be significant.

You are PROBABLY going to get 4) Tax Deductions as you will wind up getting Depreciation added as it converts to a rental property. Check with an Accountant to make sure.

Also, in 15 years.... congrats.... you WILL get 1) Cash Flow as the Mortgage disappears.

Along the way, you can possibly 5) Leverage your Equity with a Loan. Then reinvest that equity into other rentals.

Another calculation which can be done is how the Cash Flow increases over the 15 years. For instance, do a 15 year projection of rents (say increasing 3% per year) and Expense Increases (say 5% per year) and you will also understand your Cash Flow Growth.

Let's say you are collecting $2k per month in Rent or $24,000 per year.

Let's say you are paying $500 per month in expenses or $6k per year.

Year 1)

New Rent = $24k x 1.03 = $24,720

New Expenses = $6k x 1.05 = $6,300

NET is an INCREASE in Cash Flow by $720 minus $300 = $420 per year.

Funny how if your expenses are increasing more than your rents you actually still increase your cash flow.

Simple calculations but it tells a lot.

There are more to RE than just Cash Flow......

Thanks for all of your responses, here are my answers and some more details about the property....

@Lana Lee I purchased the house in 2007 for $180,000 and for the past 5 years it has been a rental property, so 5 years primary, and 5 years rental.  Rental since 2012.  There has been some appreciation, but not much.  The negative cash flow occurs when I do account for maintenance, management, Cap Ex, Vacancy, Etc.  If I do not account for those expenses, (just principle, interest and insurance) it shows a positive cash flow of $1,200/year.

@Alexander Felice My thought to increase cash flow is to refinance, which will definitely accomplish that.  However, I just refinanced within the last year and I am not sure 1) how bank lenders will accommodate another refinance so shortly after the last one 2)How will 2 refinances in the past 2 years affect my credit.

@Llewelyn A.   Thanks for your alternative analysis on this....I believe the property will be at or above the current value by the 15th year.  I will, and have been getting mortgage reduction.....that was originally what I thought to be the most important factor in holding the property.  Hopefully there will be a 3% growth in rental income per year, but I haven't seen that in the past 5 years.  (One year was college students, one year I was on a bad rental cycle and lowered rent to get it occupied, etc), but I learned many lessons along the way and can hopefully start to see that increase.

For all, here are the financials on the property.

Amount owed on loan: $153,000 

Loan Matures May 1, 2032

Principle/Interest/Taxes = $1,482 (Fixed Rate of 3.75)

Rental Income = $1,600

Thank you again for all of our advice and information, I look forward to reading more!

Dan

I would refinance if I could get positive cash flow and utilize any money you can pull out for your next deal. Negative cash flow is never good in my opinion.

Hey @Daniel Kent . The most important question right now is what are your goals in real estate and with this property? Do you want a few properties that generate some stable rental income in later retirement? Or are you looking to build a bigger portfolio of cashflowing rentals now in order to retire early or pursue a different career?

I took a look on MLS and if it's the property I think it is, my next question is, are you at market rent on it? If not, raising the rent just $100 a month brings you back to "break even" annually. The area is certainly one with a solid, stable rental market.

You'd also want to know what you might expect to sell the place for. Really this question can be boiled down to a math problem, if you are seeking out the highest numerical outcome. That's not always the case though, as chasing returns elsewhere could create more life hassle rather than maintaining your current asset.

I'd hesitate to refinance a first mortgage a bunch of times due to loan transaction costs. You could consider using the equity of the rental for another purchase instead (HELOC). Many options here. Definitely depends on your short and medium term goals.

@Daniel Kent

I think you can benefit from an Amortization Schedule using the information on the loan details.

Basically, you can see the Principal Reduction after each month payment of P&I.

Knowing that math can help you make a decision (but don't make decisions based on the fact that I buy properties on a total basis, not just Cash Flow).

Here is the Amortized Table. Note that "Total Reduction" is calculated by taking the Mortgage Balance and subtracting it from the original loan amount of $153k. The "Per Month" is the "Total Reduction" divided by the # of months in the 1st Column.

The only one issue you need to deal with is if you can carry the Negative Cash flow of $100 per month until it eventually becomes break even and then positive Cash Flow. Also, you may be getting a refund at the end of the year which may be more than the $1,200 per year negative cash flow. So it's basically carrying the 12 months negative until you get the refund. Talk to your Accountant about that.

I would have to say that a 3.75% Mortgage 15 year Mortgage is REALLY hard to be on a Rental Property.

In the future, Interest Rates will only go up. Why through it away?

Thanks @John Knisely   Of course my goal is to retire early!  Who doesn't? ;-)  And trying to reach this goal and seriously analyze new properties is really what made me take a hard look at my current property.  I am at market rent on this property.  It is in the Manayunk section of Philadelphia, which is kind of a tough area to analyze now, as they are building new construction monstrosities in any available empty lot.  There are also alot of apartment buildings with secure parking that are changing the rental market. (My house is 100 years old with street parking).  That being said, I haven't had much trouble renting it out and have not (knock on wood) encountered the tenant from hell.  So with all of those factors considered, I always thought it would be a good idea to hang onto and rent, (even if not necessarily a positive cash flow), until the single family home rental market there tanks, and I have a hard time renting, then list for sale... 

If I can find the proper funding, I would love to purchase another single family home rental property (property 2) that has a positive cash flow, use those profits to expedite the payoff of property 1 mortgage, and then have 2 positive cash flowing properties....and go from there.

The problem with paying down a mortgage is that it reduces the cash flow from the property (true cash flow) since it is only your own cash equity that is generating the income. Best you can hope to do is earn/save the prevailing mortgage interest rate on the cash which is 3.75%. Taking that same money and putting it in a income fund would generate greater returns as opposed to paying down the mortgage.

Not really worth the effort to invest at 3.75%.

Hi @Daniel Kent

My rule of thumb is "Never fall in love with the property". You probably kept the property and decided to rent it out because you fell in love with it. Of course, it's your home and you have good memories right?

You will be surprised by the number of options you have to concert a bad deal to a good deal. You probably can't make it a great deal but good is good enough :)

When you refinance from a longer term to a shorter term usually you build up equity much faster. How much equity you have? It plays an important role to what's your next step.

If you have a decent equity, you can get a heloc and use it to payoff your mortgage in as short as 5 years. With $1,200 negative cash flow, that's probably not the best you can do.

I always find that you can easily get out of that situation when you sell with "rent to own", "subject to" or "seller financing". The point is that your negative cash flow comes from maintenance, insurance, taxes, vacancy, CapEx, and management. If you sell with the mentioned strategies, your tenant buyer takes care of all expenses and your mortgage will be paid off on time.

My preferred method in this situation is to offer seller financing structured as a long-term lease option if this strategy works well in your state (your state is landlord friendly). if the tenant buyer stops paying, you don't need to foreclose on the property. You can simply file eviction and you get your property back.

I hope that helps.

Thanks @Sam Alomari   This being my first home, I of course love the property, but I love the thought of financial freedom much more ;-)  I decided to keep the property and rent it because the area has such a great rental market and I did very simple math.....(Rent>Mortgage=Win) 

I have almost $110,000 in home equity.  I am a little confused about the heloc option, where I would use a Heloc to pay off the mortgage, but then the heloc would need to be paid off as well?

Rent to own, and seller financing is a different idea.  With just principle, interest, taxes, and insurance, there is a small positive cash flow on the property.  It becomes negative when I figure in Vacancy, Repairs, and Cap Ex.  If the home loan is quickly paid off, then the cash flow skyrockets and, to me, doesn't make much sense to sell at that point, as long as the area is still a good rental market, unless I am just confused about your scenario.

@Daniel Kent just google "Pay your mortgage in 7 years" and read about the strategy. If you decide to go that route, my financial adviser can help you to implement it and actually pay off your mortgage as well as any other debt quickly. PM for more details if you like what you read about it.

The trick with the lease option "unfortunately" is that statistics shows that 85% of the tenants don't buy the property when the option expires. That works to your advantage.  Tenant buyers usually maintain your property better than renters. They believe it's their home so they will keep up the property.

I know investors that made a fortune using the lease option strategy, and they kept most of their properties after years of pure positive cash flow.

You can also invest your equity and buy other properties. You have $110k equity, so you can pull 80%-90% of your equity and if you don't mind remote investing, you can buy 2 solid rentals in the mid west that cashflow 10%+. Use that passive income to payoff your heloc and your mortgage. That actually works well with using your heloc to payoff your mortgage principal quickly. 

I am doing this exact strategy now. I have around $140k equity in my house which was appraised for $505k last year. I pulled the equity as a heloc, and I invested the money in Indianapolis, IN. If I can do it, indeed you can. If you decide to consider this approach, make sure you get interest only heloc.

I learned that you can use higher interest debt to payoff lower interest debt such as a mortgage and save tens of thousands. I paid mentors and advisers to get that kind of knowledge and to help me through the process. This probably doesn't sound right, but it's the real deal and I'm experiencing great results.

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