Is negative cash flow really always a bad deal?

21 Replies

Hi all,

First, I just wanted to say thank you to everyone who contributes to this forum. I'm learning tons here and all you fine folk make this a great resource!

Now, I'm curious what people think about (minor) negative cash flow for buy and hold rentals. Everywhere I read about it the consensus seems to be it's an instant no-deal. What about in high appreciation areas with low cap rates like larger SoCal cities? I know there's much better deals to be found with some patience, and that negative cash flow makes the property a liability. But, if you can afford to subsidize the rental income for the foreseeable future and can tolerate repairs, and you have the majority of your PITI being paid by the rent, does it not make it an ok investment anyway due to the loan payment and potential appreciation? On the other hand, it does seem like we're nearing the peak of the appreciation cycle, but even then, if the property can be held for the long term to me this still sounds like a good investment.

No...and the rationalization of using your job income to pay for it makes no sense.  That money is equal to the same thing no matter where you use it.  It doesn't change the fact you are going backwards...you're just taking it from your job income instead of the property.

When you have negative cash flow, you are paying for your property.

When you have posititve cash flow, your tenant is buying your property for you.

That's true, I am paying for my property. But, I am paying $100 while someone else is helping with $3000. I understand there's risks and additional expenses that will add up in the 30 years it takes to own the place, but it still sounds like a good way to go.

If it is supported by other investments, negative cash flow in itself is not a deal breaker for me.

I have bought several properties where the monthly income did not cover the outgo but the equity position was such that I simply could not pass it up.

One example was a small rental I bought in Georgia several years ago. The owner inherited the 2/1 rental house and the payment was $500 a month while the current market rent was in the $400 range. The loan balance was less than 8k but the house was worth between 45 and 50k. It was in the final years of a 30 year note with virtually all of the payment going to principal.

All this new owner could see was that he would have to come out of pocket $100 a month plus any other expenses that might occur. Plus like most people, all he know about rentals were "tenants and toilets." He had a couple of things he needed cash for so we struck a deal where I gave him the 5k he wanted in cash and I took over the payments on the house.

In a couple of years the house was paid off and I collected rents on the house until it was sold for a sizable profit.

I would not rely on the current market trend to make this decision for me unless my plan was to sell quickly as trends can and do change in some cases without much warning.

Good luck in your investing!

Bear in mind, many people on BP are full time real estate investors. So, no, you can't take a negative cash flow for your main "income". But in So Cal? At $3k rents and $3,100 PITI? You may make out like a bandit in 5 years time. I would say the biggest thing you need to consider is your exit strategy. Will it be refinancing, selling, raising rents after improvements? Perhaps in your situation a short term negative $100 cash flow will work for you. In my area, no way.

Here are some numbers:  Assume a property worth $100k you buy for $90k with $18k down.  That means you start with $10k in equity.  There is an average appreciation of 7% per year.

Also, assume the person with Positive CF is getting $500/m => $6k/yr, and the person with Negative CF is losing (paying) $250/m=> $3k/yr.

The initial Cost for both is the same = $18,000, and they both start with $10k in Equity.
*  Note the Cash numbers in () show accumulative +/- for that year.  Built up Equity is applied at the beginning of the following year.

Years            Positive              Negative         New Value

1
Cash*          6k (-12k*)         -3k(-21k)
Equity        10k                      10k                 100,000
Net             -2k                      -11k

2
Cash            6k (-6k)              -3k (-24k)
Equity         7k                        7k                   107,000
Net             11k                      -7k

3
Cash            6k (even)           -3k (-27k)
Equity          7.5k                    7.5k                114,500
Net             24.5k                  -2.5k

4
Cash            6k ( 6k)              -3k (-30k) 
Equity          8k                        8k                   122,500
Net            38.5k                    2.5k

5
Cash            6k (12k)              -3k (-33k)
Equity         8.5k                   8.5k                   131,000
Net              53k                      8k

After 5 years, the Positive CF has a net return of 53k (incl. cf and equity), and the Negative CF has a Net return of 8k.  However, all of the Negative returns are from Equity, and they have a net LOSS in CF of $33k.  That means, if you are stealing it from your job income, you have that much less to spend on what you are doing now.

...and, you are NOT showing a real profit...just a virtual one, that is completely dependent on future events you have no control over.  What happens if there is a downturn?  If you want to access your equity to give it real value, you have to either sell the property, which means if you sold it for full value, you would only get an 8k profit (probably eaten up at closing), or refi...which would give you an even larger negative CF.

The Positive CF answer, started showing a real profit once the CF recovered the DP money in year 3.

Well, there's an upside to investing in negative cash flow rentals - you will have very little competition and ton's of deals to choose from. 

And if you do it in California, you'll get all the benefits of someone engaging in capitalism there!

Good luck in your decision.

@Flavius Alecu I think that is a bad idea. First, I believe that we're close to the top of the cycle, so you're buying at as high a time as has ever existed, and with negative cash flow, your only hope is appreciation. So you already start from below ground 0. If the market had crashed in the cyclic area and you were buying, then I would recommend buying it... but of course if the market had crashed it would probably not be negative income to begin with.

The most important thought is opportunity cost. You can buy 1 property for -$100/month (and I'm guessing that does not include vacancy, capex, maintenance, and management), or you could likely buy 4-5 properties with total of over +$1,000/month (after calculating all the other costs) in other markets. So while your investment may work in 10 years after we come back from the next crash, you prevent yourself from any current benefit or growth in the interim as well as expose other risks (i.e. losing your job, having an emergency that causes you to sell in the down market, etc.).

Some people swear by appreciation, but I bought at the height with a negative cash flow property and it stopped me from expanding after everything crashed. I could be in a doubly-better place than I am now because I thought, "Oh well, it's sort of like saving for retirement." The property is worth more now and cash flows just fine, but that's because I had to sit on it for ~6 years to start breaking even, and another 4 to get decent cash flow. Swimming with a large rock in my pocket...

Originally posted by @Bryan O. :

@Flavius Alecu I think that is a bad idea. First, I believe that we're close to the top of the cycle, so you're buying at as high a time as has ever existed, and with negative cash flow, your only hope is appreciation. So you already start from below ground 0. If the market had crashed in the cyclic area and you were buying, then I would recommend buying it... but of course if the market had crashed it would probably not be negative income to begin with.

The most important thought is opportunity cost. You can buy 1 property for -$100/month (and I'm guessing that does not include vacancy, capex, maintenance, and management), or you could likely buy 4-5 properties with total of over +$1,000/month (after calculating all the other costs) in other markets. So while your investment may work in 10 years after we come back from the next crash, you prevent yourself from any current benefit or growth in the interim as well as expose other risks (i.e. losing your job, having an emergency that causes you to sell in the down market, etc.).

Some people swear by appreciation, but I bought at the height with a negative cash flow property and it stopped me from expanding after everything crashed. I could be in a doubly-better place than I am now because I thought, "Oh well, it's sort of like saving for retirement." The property is worth more now and cash flows just fine, but that's because I had to sit on it for ~6 years to start breaking even, and another 4 to get decent cash flow. Swimming with a large rock in my pocket...

 Well put.  Very well put.

I invest in Southern California myself and would not do this. We are probably at or near the top of the cycle in most areas, and when the unexpected happens (vacancy for a longer period or major repairs), you'll feel the pinch. There are still plenty of good areas in Southern California where you can get good appreciation and at least break even. Go look for those.  

for long term rentals in non appreciating areas or areas of historic non appreciation I get it.

I sold one of my homes in Palo Alto because I did not want 200 a month negative cash flow.. probably the worse mistake of my career.. that house just sold for 3 million and I paid 185k for it  there has been about 100k in upgrades though.

and it would have within two years been even cash flow and if I held to today it would have been cashflowing 2 to 3k positive a month on top of all the equity.. but I just could not see in 1991 that the house could get more than the 500k I a was selling it for so I made a nice lick then.. and maybe that money over the years made me the 2.7 mil I left on the table.. but you know califorina.. hard to bet against..

Originally posted by @Flavius Alecu :

Hi all,

First, I just wanted to say thank you to everyone who contributes to this forum. I'm learning tons here and all you fine folk make this a great resource!

Now, I'm curious what people think about (minor) negative cash flow for buy and hold rentals. Everywhere I read about it the consensus seems to be it's an instant no-deal. What about in high appreciation areas with low cap rates like larger SoCal cities? I know there's much better deals to be found with some patience, and that negative cash flow makes the property a liability. But, if you can afford to subsidize the rental income for the foreseeable future and can tolerate repairs, and you have the majority of your PITI being paid by the rent, does it not make it an ok investment anyway due to the loan payment and potential appreciation? On the other hand, it does seem like we're nearing the peak of the appreciation cycle, but even then, if the property can be held for the long term to me this still sounds like a good investment.

 No. Cash flow negative is not ALWAYS a bad deal. If someone tells you it is, they are an idiot. Look at it logically. If you bought a house in LA in 2014 for $400k & you placed a tenant in there who caused you to be cash flow negative until....say today when you decided to sell it for $850k. Was that a bad deal? Of course not. Hell, even in the midwest we've seen huge appreciation coming out of the great recession. Pretty much every house i've purchased between 09-14 house gone up 30%-50%.

You can't assume that there's going to be appreciation. If you buy a negative CF property and it appreciates a lot over the next few years like it did in the bay, I would say that's lucky but not a smart investment.

I'm assuming you're not even accounting for reserves in case of vacancy, repairs, capex, etc...which makes it even more risky.

That being said, if you're super wealthy and can take the hit in case things don't go your way. Maybe you can take that risk. 

For us, negative cash flow properties aren't investing, they are speculation. You're betting on the market to continue increasing and markets don't necessarily behave that way - so it's very speculative. Speculation is fine, if you recognize it for what it is, and that's what you want to do. At this point in our investing, it's a no-go for us, because we don't want to be speculative. 

All "idiots", please raise their hands:

      O
OO O
|||||   O
|        \/  /    <<<<<<  Like an "idiot", I raised my hand.
\           /  
  \        /
  {       |
   |     |

As you are seeing here there are 2 camps so ultimately you have to make up your own mind. Broadly speaking your lowest risk position is positive cashflow only. It's very hard to go broke that way. HOwever as you stated initially there are many high appreciation markets where negative gearing can make sense. I do both and I make probably a hundred times more out of my negatively geared homes when I sell them than I ever will out of small cashflow per month. But I carry the risk of de-gentrification, economic adversity and literally running out of money in a bad market.

The attraction is making 50 to 100K in a 24 month period from one deal. That buys a lot of cashflow :-).

So as my accountant once said, "if you're going to play that game make darn sure you win at least 51% of the time".

No, negative cash flow is not the end of the world.  It's just harder and you have to make money elsewhere.  But you can benefit from appreciation, which is the biggest wealth builder in real estate.

Originally posted by @Adrian Chu :

No, negative cash flow is not the end of the world.  It's just harder and you have to make money elsewhere.  But you can benefit from appreciation, which is the biggest wealth builder in real estate.

 You have the benefit of the exact appreciation if it's positive.  Negative CF adds to your cost.  Positive CF subtracts from it.  CF is liquid, which means it is mobile, which means it has an exponential return in the outside world.  Appreciation is not mobile.  It sits in the property on life support until it is released when the property is sold.  

Equity gained through appreciation has a 1 to 1 ratio of "face value" to "real value".  If you start with 20% down on a 100k property that means your bought 20k/20% in equity but the true value is 100k.  The property value will increase at the same dollars over time.  This means if the property appreciated 5% over the next year, the equity would be 25k and the PV would be 105k.  The face value to true value ratio is now going down.... 1 to 4.2.  Appreciate another 5% the next year, and the equity would be 30k and the PV would be 110k for a FV to TV ratio now of only 1 to 3.67.  If over the next 3 years (year 5) you averaged 5%/yr, you would have 49k in equity and a PV of 129k for a ratio of 1 to 2.67

Why does this matter, and how does this relate to CF?  Assume you have positive CF of 4k/yr on this property.  Using the same timelines as above, after 1 year you would have 4k in CF and 5k in appreciation.  AFter year 2 you would have 8k in CF and 10k in appreciation.  After 5 yrs you would have 20k in CF and 49k in equity.  Sounds like the equity gain is even better than the positive CF model.  No so.  Here's why.

The last scenario keeps everything in the same property.  What if we did two things:  1 - We took all the CF and added a 2nd property like this one?  That would add another 4k per year and get us 8k per year. Try that with negative CF.  This not only increases the CF, but it also increases the equity for each year following since both with be twice what they were previous.  Wait, with two properties, in 2.5 years I can buy a third property.  Now I have 3 CF and equity increases/year.  How fast can I get to the 4th set, then the 5th, then I start doubling up properties per year, then I ....  

STOP!!!.  

I forgot, we have negative CF.

Originally posted by @Suzanna Smith :

@Flavius Alecu I’m curious to hear how this went! We are about to do the same thing in the Seattle market. 

It's going well! Closing in on the end of the second year. Bumped rent after first year (changed tenants) and am not cashflow negative anymore. Just barely though. Like people here say, as a standalone investment it's not the best and I can imagine if you'd want to spend the time to find better opportunities they will be out there. Personally, I'm happy with my choice.

Good luck!


@Flavius Alecu sounds like your speculating and willing to pay a fee over time for it. I mean you’ll see better options so it’s like why bother unless your thinking the areas going to get a big boost and you have other revenue streams able to pay off the negative cash flow without a hitch or a bump then it can be worth it. But it’s like going to the store and looking at the apple with a brown spot when all the other apples are Bright red and fresh

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