I lose $20k/year - help me w/ my strategy!

Laura Williams · 2019-01-21T21:28:31-08:00

Sooo I have three houses that are all former primary residences that are now rentals. None of the homes were bought with the intention to rent them out, so the sale price and mortgages weren't optimized to be rentals. The homes are in California and Texas and have very high property taxes. Basically the math breaks down to:Home 1: 6,800 in rent6,928.40 in expenses-128.4/moHome 2:2325 in rent3,206.57 in expenses-881.57 / mo(this one has a 15 year mortgage, so if we refi-ed to a 30 year expenses would of course be much lower)Home 3 4,500 in rent5,164 expenses- 664 / moThis all adds up to a loss of $1,673.97/month or $20,087.64/year.I can easily afford the loss. I make $500k+/year (with a healthy amount invested/saved every year.) I also make $30k/year in dividend income from my investments which I could use to cover the loss on the houses. So I'm of two minds in how to think of this. On the one hand, I'm getting three homes with a current valuation of $3m combined for 20k/year. That doesn't sound so bad. And since they all have fixed rate mortgages (theoretically! hopefully!) rents will continue to rise while my payments will stay the same. And one day of course I'll have the mortgages paid off and still be collecting rent.BUT on the other hand . . . they are all money losers right now! I could sell some or all of the homes (they're all fairly recent, so no breathtaking appreciation, but no losses either) and just invest the money in index funds instead.So . . . what do you think of my situation? What would you do?

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

7y

Originally posted by @Dave Reese:

@Joe Villeneuve 600k in loss not counting capitol gains of how many millions...

You missed a later post of mine describing the rest of the negative math.

0 Reply

Anthony Dooley

Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes

7y

These are not assets, they are liabilities. Not only are you losing $20K per year, but also the opportunity cost that you are missing from better investments that actually make you $20K per year. That's a $40K swing in position. They are also killing your debt to income ratio, if by chance another opportunity comes along, Hopes of future appreciation do not make up for the actual losses now.

2 Reply

Russell BrazilBusiness Member

Moderator

Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes

7y

Originally posted by @Joe Villeneuve:

Originally posted by @Mark Sewell:

Originally posted by @Joe Villeneuve:

Let's do the math.

$20k/year, over a 30 year period = $600k loss.

Your story problem here assumes that all the parameters remain static over the 30 year period. Rents will go up over time.

I suspect this is likely a short-term financing discussion.

Ah I see your later posts, with the rest of the assumptions. Yep.

I would imagine that one of the three properties, say the one in CA, does not cash flow and will not likely cash flow in the future, then it might make sense to go ahead and sell off that one, and reinvest elsewhere.

Rents go up...costs go up.

More cash flow indicatices higher risk, which means higher deltas from pro forma returns. Lower risk tends to have deltas that out perform the pro forma. The delta range from the pro forma is the often ignored factor in any analysis. Returns are not guaranteed. They are not the end result of an equation. They are a high range of possibilities, but the higher the risk, the larger the delta becomes both above and below the pro forma, but with the greater spattering of possibilities landing below the pro forma on high risk, and the greater spattering of possibilities above the pro forma on the low risk.

The negative cash flow created yearly on these, is like a months credit card bill at this income level. Its lower than my credit card bill from last month. The value of the portfolio, using conservative asset growth price, and debt reduction is valued at roughly $8 million after 30 years. Rent growth will outpace other areas of higher cash flow most likely. Some of the doors I bought a decade ago where I was barely breaking even are now at $1500-2000 a door. And these are at much lower price points than the subject properties in the post. Have my costs gone up, absolutely...have they gone up as much as my free cash flow, not even close. My lower class cash flow properties though have had rents essentially stay the same while my costs have gone up, creating less cash flow on those over the last decade.

Ill take a break even, even slightly negative cash flow property in an A class, high rent growth area all day long these days, because I know Im going to end up with far more cash flow over time than if I bought a riskier cash flow property. Another often overlooked thing, its not the properties that create the negative cash flow here. It is the investor that creates the negative cash flow by choosing to leverage. The negative cash flow is from the risk in leveraging. The risk of leverage is completely independent of the risk of the asset and the risk of the market.

These properties very well might not be in high rent growth areas though. Not all A class areas have high rent growth, even in greater rent growth markets. Areas with tons of development, think like outer outer suburbs of major cities experience lagging rent growth because of the constant supply of new housing being built. Where supply remains constrained, where building is high, closer to city centers, is where rent growth will typically be high, as long as demand continues to grow.

[email protected]301-893-4635 Podcast Guest on Show #192

District Invest Group546 Reviews

Website View Page

15 Reply

Adam M.

Rental Property Investor · Fort Collins, CO · Member since 2008 · 168 posts · 105 votes

7y

I'd unload those things as fast as possible and 1031 into a better vehicle.

0 Reply

Stephen GallagherPro Member

Real Estate Agent · Hillsboro, NH · Member since 2019 · 80 posts · 54 votes

7y

@Laura Williams

I am curious why you don't pay down the principal and pay them off.

Refinancing to 30 year makes no sense as you start over paying interest only.

Take some of your surplus income and pay off the properties and turn all of that into positive cashflow.

You would benefit from searching You Tube for terms like,

Pay off your mortgage early

Stacking pay off

HELOC payoff mortgage

Seems to me you are in a position to be debt free and income rich in just a fee years.

Not sure what your equity is or appreciation, but another option would be to do 1031 exchanges.

Good luck.

StephenGallagher

4 Reply

Steve Vaughan

Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes

7y

I see both arguments, asset appreciation and cash-flow. Because I have both. But I do this full-time between naps.

If I were a hobbyist with 3 'accidental rentals'? Where these just represent 3 large assets I have to worry about, that don't fit my goals or tickle my why? I'd list and sell them. Maybe not all in same year, depending on cap gain, but I'd sell.

You're heart's not in it. Hobby landlording should be an oxymoron.

11 Reply

Dan Mcclain

Member since 2019 · 4 posts · 2 votes

7y

Why are your expenses so high? And why is the rent so low it doesn't cover expenses? How did you arrive at the expense totals? Are those an average of what you've spent so far? Will the expenses go down once certain things are taken care of?

Reduce your expenses and raise the rent. Sell the one that falls within the IRS timeframe limit.

For people who move every few years, a better strategy is buy a house that needs updating. Do the updates while living there, then sell at a profit. Repeat.

1 Reply

JD MartinBusiness Member

Moderator

Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes

7y

I don't think there's enough information to really make a decision here. You should be calculating your return independent of principal pay-down, because that is just paying yourself back. And if you wanted to get really fancy you could calculate it independent of tax benefits as well (though most people don't bother getting that detailed). Without knowing your cash on cash return for each property, it's difficult to gauge it against any other way in which you might be investing the money. Let's say for sake of argument these properties were, and can be expected to continue, rapidly appreciating in value. In that case, you weren't 'losing' money but rather investing more money into the asset. Let's say they were on 10 year mortgages; that would be a similar situation, in that you were simply swapping liquid (cash) for illiquid (RE) assets.

That said, since you don't appear to be inclined to continue in RE in any case, you are probably best suited to sell and move your assets into something where you have an interest. Leaving money in assets that don't interest you at all is a good way to lose money without some kind of professional, responsible management.

Podcast Guest on Show #243

Skyline Properties

View Page

5 Reply

Account Closed

Investor · Surprise, AZ · Member since 2018 · 156 posts · 110 votes

7y

@Laura Williams, I am in a similar situation with what was my primary home. I have made the decision to sell it once the lease is up for the current tenants in June. The proceeds from the sale will go to buy a flip/or a new rental property that actually cash flows for me.

I'm probably losing close to $1500 mo with all expenses, but selling it will bring me back almost $3500 mo freed up and a chunk of cash!

1 Reply

Rob Golob

Investor · Valparaiso, IN · Member since 2015 · 84 posts · 47 votes

7y

With the information we have, we have no idea if the OP is losing money or not. ALL we know is there is a negative cash flow.

That said - I vote sell. Not because of the numbers but because of the landlord by default situation.

1 Reply

Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

7y

Originally posted by @Steve Vaughan:

I see both arguments, asset appreciation and cash-flow. Because I have both. But I do this full-time between naps.

If I were a hobbyist with 3 'accidental rentals'? Where these just represent 3 large assets I have to worry about, that don't fit my goals or tickle my why? I'd list and sell them. Maybe not all in same year, depending on cap gain, but I'd sell.

You're heart's not in it. Hobby landlording should be an oxymoron.

Hindsight is 20/20 I should never have sold my BAy area properties.. bought Milpitas 1977 for 80k.. would have been negative at the time to keep it.. now its worth about 750 and would be paid for and rents probably 3 to 4k a month.

sold my palo Alto house I paid 180k for in 1983 same thing I could not fathom how I could handle 300 a month negative.. and how it would go up anymore than what I sold for which was 450k.. in 89.. now its worth over 2 mil and would be paid for rent 6 to 7k a month

and I could go on to 3 others.. its a long game. if you don't need rental income and can afford some negative no sweat then A class in known high value markets is not a bad bet for retirement years.

Podcast Guest on Show #222

JLH Capital Partners51 Review

Website View Page

12 Reply

David Noh

San Francisco Bay Area · Member since 2019 · 24 posts · 6 votes

7y

@Jay Hinrichs

May I ask what your thought on this discussion is ?

I see alot of people worrying about cashflow but OP hasn't mentioned how much equity she has in these houses and how much equity is gaining by paying mortage each year.

She could be coming out positive in terms of net worth no?

1 Reply

Justin Kane

Specialist · San Antonio, TX · Member since 2015 · 909 posts · 297 votes

7y

It depends what your goal is? are you 15 yr noting so you can pay them down and purify cashflow on semi liquid assets? or are you as of RIGHT NOW looking to profit? if its the later then I suggest selling at the top of a cycle (which we primarily are in) and taking 1031 into a single apartment investment (NOT REIT) if you are trying to build wealth then I suggest get into a property that on 30-40 year in a c class neighborhood with large delta on cashflow take that difference to offset your redlining properties and just sit on the balance until your assets are paid off

0 Reply

Steve B.

Engineer · Portland, OR · Member since 2014 · 1k+ posts · 1k+ votes

7y

@Laura Williams sell or keep them as investments to 1031 them as soon as feasible. You can get both appreciation and cash flow in the same house, although you normally can’t optimize both. Keeping a negative cash flow house and hoping for appreciation is not a sound investment strategy. Keeping houses not bought as renters then using them to rent is a very common mistake, it almost never works out, yet people get emotionally attached to these houses and will go through mental convolutions to rationalize holding them unprofitably.

0 Reply

Arlen Chou

Investor · Los Altos, CA · Member since 2014 · 942 posts · 1k+ votes

7y

@Laura Williams there is too much assumption going on to create any type of a strategy. First, you probably should let everybody know WHERE each property is located. A property in Modesto Ca is very different than a property in Palo Alto Ca. Conversely a property in Austin Tx is very different than a property in Lubbock Tx. Second you have not stated if these are all SFR's or condo's or town homes. Thirdly you should let everybody know WHERE you are located so tax considerations can be folded into any suggestion. As an example, if you are in CA, you are getting killed on income taxes and property taxes on your Texas holdings. Remember your CA properties have Prop 13 working for them, so over time property taxes will be more tempered in CA vs Tx. Thirdly, you should let everybody know how long you lived in the last home and when you moved out. This goes directly to the point of capital gains taxes. Without this basic info, you will only get extremely generic opinions... but that is just my opinion ;-)

7 Reply

Scott D Burrows

Rental Property Investor · Indianapolis, IN · Member since 2018 · 128 posts · 113 votes

7y

@Laura Williams

I agree with @Jay Hinrichs . If you have any passive interest in real estate at all, I would advise syndication ( basically you fund part of a large investment, typically in Multi-Family, with a certain rate of return and portions of the profits).

1031 out of properties is fine, but if someone doesn't have experience or want to take the time to analyze deals and ensure that their numbers are right on the smaller deals, it will be difficult in the larger deals as well, although not impossible. If you are 100% confident in your analysis abilities go this route, otherwise stay away from this option.

Selling them all is a little naive as well. What happens to the profits from these and also what happens to all of this profit, it would impact your income in a very negative way, especially considering your current tax bracket (this would be a way to take 30% losses on $1MM+). In other words, some are saying to guarantee a 30% loss (on the taxed income) by selling or a $300K loss, GUARANTEED LOSS, with little respect to what you actually owe on the homes. Again, I don't think this is the right way to go.

I would highly recommend working with Jay and find out ways that you could syndicate larger, passive real estate investments and determine a strategy to at least break even on the properties, with possibly selling one or two properties OVER TIME, NOT at once. Keeping one would probably help you out during tax time anyways, especially since at the tax bracket you are in, makes more sense to have some passive losses to offset your high-tier income.

In conclusion, here are my recommendations:

Syndicate large, multi-family real-estate deals (talk to Jay about how to do this, he knows his stuff).
Find your biggest "loss-vehicle" and eliminate it, either by selling or correcting/minimizing issues through some additional investment if needed.
Sell off house by house over a period of about five years, to minimize any one years impact on your taxes.
If you have someone that you TRUST, consider 1031 process. If you don't, stay away from this, just because you can sell and trade up, tax-free, doesn't mean that it will benefit you- might just benefit the person facilitating the transaction or fees that they can charge, commissions, etc. BE CAREFUL.

Anyways, good luck and if you need anything or want to brainstorm, feel free to reach out!

Good Luck!

Scott

4 Reply

Laura Williams

OP

Member since 2008 · 7 posts · 10 votes

7y

To answer some of the questions that have been raised, home #1 is in Venice, CA (socal), homes number #2 and #3 are in Austin TX 78702, holly street area right on the river. I reside in Texas.

Without getting more detailed on the numbers I have a lot of equity in home #1 (bought for 1.6m, about 1m left on mortgage) and hardly any on 2 and 3.

As far as goals I want to build long-term wealth. I don't need the cashflow right now which is what brought up this whole issue, but I'm also listening to the point of why have negative cash flow when you can have positive. But my larger goal is to build wealth and eventually have income coming in from properties, maybe in retirement. (I'm 34 right now.)

Again I really appreciate everyone who has taken the time to post!

1 Reply

Laura Williams

OP

Member since 2008 · 7 posts · 10 votes

7y

To those wondering why my expenses are so high, that's just the cost of the mortgages + taxes. The maintenance and insurance costs are minimal. They are just expensive properties with expensive mortgages.

I lived in home #1 for two years, home #2 for two years, and didn't live in home #3 (it was custom built with the idea that we'd live in it but then we didn't end up doing so.)

So far being a landlord has been relatively easy, but home #1 is old and does have regular maintenance issues. 2 and 3 are brand new so no maintenance issues yet.

Some of you mentioned getting emotionally attached to houses that were former homes, and I can see how that is definitely at play here. I have gotten clarity from your responses that home #1 is one we may want to live in again in the future and it's a location I really love. So I think I will hang on to it for that reason alone, and be clear that it's a hobby not an investment! Still have to decide what to do with 2 and 3.

0 Reply

Uwe G.

Vancouver, WA · Member since 2014 · 127 posts · 60 votes

7y

Hi @Laura Williams,

Lot's of good feedback on this board. I am more in the camp of holding onto assets vs. selling them but that depends on a couple of factors. My first question would be how cheap is your debt? What interest rate are you locked in at? If you are locked in below 4% I would keep the properties and utilize the losses against your large income (cheap fixed debt is worth a lot). My second question would echo some of the other folks, if you can sell the most recent house that was a primary and qualify for tax free gains I would do this if the gains are large (i.e. net 100K or more). Finally, are the specific locations of these houses in premium locations? If so I would keep them if not, I would think about selling.

0 Reply

Alvin Sylvain

Los Angeles · Member since 2018 · 464 posts · 471 votes

7y

@Laura Williams What does your tax accountant tell you under the new tax laws? I remember back in day, particularly in California, when investors would regularly buy money-losing properties specifically for the appreciation and tax write-off against a high income. I do not know whether that's still feasable under current tax law.

0 Reply

Joel Fine

Rental Property Investor · Leander, TX · Member since 2018 · 183 posts · 264 votes

7y

This is a great question, one that all RE investors grapple with: Am I better off keeping an asset I own, or selling and redeploying?

You are missing one very important piece of information: how much equity do you have now? The properties may be worth $3M but how much debt do you have on them? The key question: how much would you walk away with (after debt pay-off, transaction costs, and taxes) if you were to sell the properties?

You are also missing some elements of the net, after-tax return you are getting from the properties. You are losing 20k per year in cash flow, but that's offset by principle paydown and tax benefits of depreciation (which are quite predictable) as well as appreciation (which is not predictable).

Once you know the net, after-tax equity AND the net, after-tax return you are getting, then you can meaningfully compare with alternatives. Appreciation will be the wild card - you could deal with that by running a few calculations using different numbers for apprecation.

Index funds over very long periods have returned about 10% per year. Compare that with the net return you are currently getting on your equity. Then you can decide whether you are better off selling.

3 Reply

Dan H.Pro Member

Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes

7y

Originally posted by @Joe Villeneuve:

Originally posted by @Justin R.:

@Joe Villeneuve that's not all the math, let's keep going.

1. Equity pay down = 2.7 mil (estimate)

2. Long term appreciation = 3 mil (conservative over next 25 years)

3. Rental income appreciation = eliminates operating in red in 8 years (estimate)

4. Tax benefits

Unless your actually going to sell these, spend the net proceeds, appropriate time, and energy to buy "better" cash flowing properties, keep what you have. Your obviously doing well, this is a forced savings account creating a lot of wealth.

OK, as you say, let's add ALL the math into this:

1 - Added costs for CAPEX at 5% per year for next 25 years = $200k (estimate)
2 - Losses from reinvestment of negative cash flow and CAPEX, compounded at a conservative 5% per year for next 25 years = $11.7 M (estimate)
3 - Lost Rental income from reinvested losses
4 - Lost Tax benefits from new assets acquired using reinvested negative CF and CAPEX

How did you get the $11.7M number? For a high order cost of the negative cash flow:

I took the cost of $20K at your rate and came out that the first $20K (The only one that would actual compound over the full 25 years) and $67.7K. This is the year that would have the highest compounding cost so every year would be less than this. $20K * 1.05^25.
Then multiplied that by 25 realizing this number provides a far worse number than actual because I used only the worse year multiplied by 25. we know that the last year of the 25 years has no compounding. I got $1.69M.

I calculated the cost of the negative cash flow over 25 years to be significantly less than $1.69M. Do you see something incorrect in my numbers/logic?

1 Reply

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

7y

Originally posted by @Dan H.:

Originally posted by @Joe Villeneuve:

Originally posted by @Justin R.:

@Joe Villeneuve that's not all the math, let's keep going.

1. Equity pay down = 2.7 mil (estimate)

2. Long term appreciation = 3 mil (conservative over next 25 years)

3. Rental income appreciation = eliminates operating in red in 8 years (estimate)

4. Tax benefits

Unless your actually going to sell these, spend the net proceeds, appropriate time, and energy to buy "better" cash flowing properties, keep what you have. Your obviously doing well, this is a forced savings account creating a lot of wealth.

OK, as you say, let's add ALL the math into this:

1 - Added costs for CAPEX at 5% per year for next 25 years = $200k (estimate)
2 - Losses from reinvestment of negative cash flow and CAPEX, compounded at a conservative 5% per year for next 25 years = $11.7 M (estimate)
3 - Lost Rental income from reinvested losses
4 - Lost Tax benefits from new assets acquired using reinvested negative CF and CAPEX

How did you get the $11.7M number? For a high order cost of the negative cash flow:

I took the cost of $20K at your rate and came out that the first $20K (The only one that would actual compound over the full 25 years) and $67.7K. This is the year that would have the highest compounding cost so every year would be less than this. $20K * 1.05^25.
Then multiplied that by 25 realizing this number provides a far worse number than actual because I used only the worse year multiplied by 25. we know that the last year of the 25 years has no compounding. I got $1.69M.

I calculated the cost of the negative cash flow over 25 years to be significantly less than $1.69M. Do you see something incorrect in my numbers/logic?

5% every year on the total for each year. The total for each year includes a new $20k.

0 Reply

Jimmy O'Loughlin

Member since 2018 · 6 posts · 0 votes

7y

@Laura Williams I agree with everyone that has said to sell them. A bad investment is a bad investment and your others should not have to cover for them.

0 Reply

Christine C.

Flipper/Rehabber · Indianapolis, IN · Member since 2013 · 61 posts · 43 votes

7y

@Laura Williams IMO, while there are additional benefits of principal reduction, income tax savings and long term appreciation of assets, your REI should STILL be cashflow +. I'm with the others on a 1031 sale (happy to recommend an AWESOME Exchange Intermediary if needed)

1 Reply

I lose $20k/year - help me w/ my strategy!

I lose $20k/year - help me w/ my strategy!

Most Popular Reply

122 Replies