100% Financing = No Cash Flow?

Question

Hello friends, I am thinking of pulling equity from a paid-off rental and use the money as downpayment on another rental. The rest of the money will also be from another loan. In effect, it will be 100% financed by debt. I have yet to find a property who gives me good cash flow after 2 loans, property management fees, repair expense reserve.

Is it just because the price of the property is too high? Am I doing this wrong?

Thanks!

Is it just because the price of the property is too high?  Am I doing this wrong?

Thanks!

Tim Delaney · Answer

@Diane Tycangco yes, the net effect may be the same on cash flow today. But you now own two houses that the tenants are paying your debt down which is increasing your equity faster. Remember investing is not only about cash flow, debt pay down and property appreciation are important wealth building tools.

In addition as you raise rents every year by a certain percentage you will be gaining cash flow faster than if you only had one property. For example if property A rents for $1000/month and you raise rent 5% you now have $1050 income. If you have that second house with the same rent you increased monthly cash flow by $100 instead of $50.

Joe Villeneuve · Answer

You buy 2 of the same as the first.  Not "as the first" is now, but as it was when you first bought it.  This means you are buying in a market where the cost is $100k.  That's not "less of a house", that's the same house in a different market.

Wayne Brooks · Answer

100% financed properties Rarely cash flow.

Joshua Janus · Answer

@Diane Tycangco Joe is right. You are refinancing the first loan so you are taking on more debt on that asset and applying the equity to the next. You are then taking on a separate new loan for the 2nd property and using the refinance cash to make the down payment. When you are running your numbers, you aren't 100% financed. You have to re run the numbers on your original property as you are now paying a higher monthly debt payment as you decreased your equity stance.

Diane Tycangco · Answer

Hi Joe, your explanation is great.  However, what you said above, "since doubling the equity also should mean you can buy 2 of the same deal as the first"  wouldn't apply because you are buying the 2nd property later, mean this 2nd property would already have appreciated before you bought it, so you wouldn't be able to buy 2 x $100k each, you might have to buy "less house" for the $200k and the increased total rental income might not really be double the first.

Or is what I said irrelevant since your point is your overall return is increased anyway?

By the way, I am Chinese, hence the Chinese puzzle!

Cheers!

Joe Villeneuve · Answer

This is all true, except you're missing the most important link between that added cash flow of multiple properties and the equity gains.  When a property gains in equity, it gains it on a 1 to 1 ratio of appreciation to equity.  Forget the paydown.  That happens at a snails pace and has its only real value in that the tenant is paying it down and not the REI.  When you buy the property, you are buying the first 20% of the equity, but that equity (the cost of the property to the REI) is worth 5 times its face value in Property Value.  So as that equity growth from appreciation increases the equity, at a 1 to 1 ratio, it is actually losing you money because it is diluting the value of your equity.

Example:  $100k property, 20% ($20k) DP and initial equity.

When the appreciation increases the PV to $120k, the new equity also increases to $40k, but its value is reduced from 5 to 1, to 3 to 1...you're losing money.  If you sold the property, that $40k in equity would now be used as a 20% DP again, at a 5 to 1 value, and buy you a property worth $200k...not just $120k...and your cash flow should double since doubling the equity also should mean you can by 2 of the same deal as the first.  So, if as in your example, that $1000/month rent, (assuming a $500/month CF) would only increase the CF by that 5% ($50/month).  By following my scenario, that CF should go up $500/month...not just $50.

Diane Tycangco · Answer

So in effect, the cash flow in the refinanced rental is going to go down so that the new rental will cash flow.  Wouldn't the net effect be the same?   I should look for a property which would add more cash flow than what the additional debt burden would be on the first property for it to be worth it, is this right?

Where can I find properties that cash flow even with 100% financing?

Joe Villeneuve · Answer

Not true, however this really isn't a 100% financed property anyway.

Drew Sygit · Answer

In our opinion, you should really look at the combined numbers from both properties as well as them separately, to make sure the investment makes sense.

100% Financing = No Cash Flow?

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