The Negative Cash Flow Club!!
Real Estate Agent · Minot, ND · Member since 2021 · 131 posts · 223 votes
The Negative Cash Flow Club!!
Most Popular Reply
Nothing wrong with cash flow negative, as long as you understand what you're getting into and have the reserves to cover the loss.
That said, a lot of people go into negative cash flow without understanding the risks. I know a lot of investors who were using this method to scale back in 2004-2007, and they learned the hard way that markets don't always go up. Many of them were over-leveraged, under-capitalized, and weren't prepared for a spike in vacancies and bad debt.
It all boils down to your ability to absorb risk, and only you know what that looks like.
65 Replies
- Member since 2018 · 1k+ posts · 1k+ votes4y
Originally posted by @Axel Meierhoefer:
Any money you put in a bank account belongs to the bank and when you read the fine print of your account opening agreement, you are lending that money to the bank.
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If people worried about counter-party risk, Axel, no one would get out of bed in the morning. This is especially true when you figure that most people with bank deposits are with banks that are federally insured.
Originally posted by @John Clark:
Originally posted by @Axel Meierhoefer:
Any money you put in a bank account belongs to the bank and when you read the fine print of your account opening agreement, you are lending that money to the bank.
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If people worried about counter-party risk, Axel, no one would get out of bed in the morning. This is especially true when you figure that most people with bank deposits are with banks that are federally insured.
Well stated. Furthermore, regardless of the exact semantics of who owns the money you deposited, it doesn't really matter from the perspective of the investor who deposited money into his/her bank account. It's still liquid enough whereby it shouldn't alter or change your investment strategy.
- 4yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Originally posted by @J Scott:
Originally posted by @Joe Villeneuve:
Locked up cash has no use when it's locked up.My $.02...
Locked up cash has HUGE value as risk mitigation. It's both catastrophic insurance and a long-term asset preservation strategy.
If what you say about locked up cash is true, the optimal strategy would always be to leverage as much as possible -- even greater than 100% LTV when possible. And again, for those of us investing back in 2008, we know that maximum leverage (especially at or above 100% LTV) isn't necessarily a good thing.
My entire portfolio is leveraged at about 72% right now. That 28% locked up equity/cash is what helps me sleep well at night. It's my Plan B. My cushion. The cost of that locked up cash (inflation, opportunity cost) is well worth it to me.
That said, to each his own...
As well as when you move to bigger deals equity and the more you have is very much favored by your lenders/bankers.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes4y
Originally posted by @J Scott:
Originally posted by @Joe Splitrock:
@Amy Raye Rogers I wouldn't include CAPEX in a cash flow calculation, because those are capital improvements.
I'm guessing you'd agreed, Joe, but for the others reading that might not be as experienced...
I wouldn't necessarily include the upfront capex required to get a property rent ready in cash flow calculations, but I *do* include a prorated ongoing/long-term capex as part of my cash flow assumptions.
For example, if I'm going to spend $10,000 every 25 years on a new roof, that hits my cashflow an average of about $400/year, or about $33/month. I would definitely count that $33/month for long-term roof capex as part of my cashflow. In fact, I typically assume about $75-100/month for all prorated/long-term capex on each of my single family properties.
Right, I should have clarified, her upfront rent-ready rehab costs is what I wouldn't include as a year one lump sum cost. These occurred before it was in use as a rental, so they are rehab costs that are capitalized. As you pointed out, long term CAPEX is allocated over a period of time. The roof in your example that lasts 25 years is a $396 per year expense. CAPEX is the hardest expense to account for, because it not a fixed or defined expense. You know it will happen, just not when or how much. I had a roof last 42 years and another needed to be replaced in less than 15 years. You are making an average assumption, which you have to do. If you don't allocate anything for CAPEX, it will creep up on you.
- Real Estate Agent · San Antonio, TX · Member since 2017 · 814 posts · 466 votes4y
You are definitely not making any cash flow $, and most likely you are incurring on expenses regardless of the appreciation of your properties. Just consider making a mediocre 8% ROI on an IRA or else on your 84K investment which you are draining money for "appreciation" on RE properties, not to mention paying the lenders premium on loans etc. Cash flow is King!
- Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes4y
@Josue Vargas - cash flow is necessary for operations, even vital, but in the end wealth is created through equity. It's very hard to earn a million through cash flow (or at least it takes a long time). It's much easier to generate a million in equity. I always advocate for finding the right balance between the two.
I just closed on another "negative cash flow club" SF last week. In a desireable neighborhood for 211k, rehab will be 70k, ARV in the low 300s (which is high for Milwaukee) and rent will be 2k, so well below the classic 1%. It will only be slightly cash flow positive, but principle pay down alone is substancial, it provides plenty of tax shelter for higher cash flowing properties and it is well set up to take advantage of appreciation. That's why I am going more and more in this direction.
- 4yAxel MeierhoeferPro MemberRental Property Investor · Escondido, CA · Member since 2017 · 684 posts · 550 votes
@Marcus Auerbach I wonder if you assume that the cash flow from cash flow properties an investor owns goes into consumption by the investor? I always suggest it should be used for accumulation and then reinvestment into more properties.
When you say: It's very hard to earn a million through cash flow (or at least it takes a long time). It's much easier to generate a million in equity. I always advocate for finding the right balance between the two.
it appears that you would not use cash flow for accumulation and reuse.An important part of the appreciation is market-driven, so having two properties in similar markets, one having cash flow and the other doesn't, anybody would favor the latter.
Even in a market where one has only appreciation and zero or negative cash flow and the other has mainly cash flow and no appreciation, I believe the use of the cash flow is important.
If I buy 2x $150K properties in cash-flowing markets versus the $300K property you mentioned and cash flow $500/month in each, I can buy the third $150K property about 30 months later (assuming no rent increases, etc.).
Another 18 months later I can buy the next (to have 4), another 15 months later the next to have 5, then a year later another one to have 6, another 9 months later the next to have 7, and again 9 months later the 8th.
That means in about 8 years I have $1+ million in asset value (assuming none of my $150K properties ever had any gains in equity) and make $4000/month in cash flow (assuming I never increase the rent even $1 in 8 years).
Is 8 years a long time? Maybe. Will you have generated enough equity to pay you at least $4000/month forever in less time?
- Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes4y
@Axel Meierhoefer - agree, profits should alwaybe be reinvested. I have a fundamental problem with the cash flow lifestyle that uses RE as an ATM. You are basically proofing my point - keep doing your math and see how long it takes to make a million in cash flow. Even with $4,000 a month it takes 21 years!
But: if you have 9 properties each $150k, thats $1,350,000 in assets. Assume 3% principal pay down and 3 % appreciation (conservative) you can generate a million in equity much faster. Maybe you can add value through remodeling, maybe appreciation is higher than 3%. In fact, equity growth dwarfs cash flow.
Now, here is the other consideration: I am more interested in growing financially than adding doors. In fact I want to keep my door count to a minimum, because every door adds overhead, in PM, in accounting, in turnover, in maintenance - just headspace. So it's a classic optimization problem, how can you maximize one while keeping the other as low as possible. That's what leads you at some point to higher value properties.
8 years is not a long time. I have been doing this (investing) for 15 and I always tell people to think in decades, not months or years. When you look back from the year 2032, was this a good decision, did you buy the right property? This leads you to think more about the quality of your investments!
- Real Estate Agent · San Antonio, TX · Member since 2017 · 814 posts · 466 votes4y
Originally posted by @Marcus Auerbach:
@Josue Vargas - cash flow is necessary for operations, even vital, but in the end wealth is created through equity. It's very hard to earn a million through cash flow (or at least it takes a long time). It's much easier to generate a million in equity. I always advocate for finding the right balance between the two.
I just closed on another "negative cash flow club" SF last week. In a desireable neighborhood for 211k, rehab will be 70k, ARV in the low 300s (which is high for Milwaukee) and rent will be 2k, so well below the classic 1%. It will only be slightly cash flow positive, but principle pay down alone is substancial, it provides plenty of tax shelter for higher cash flowing properties and it is well set up to take advantage of appreciation. That's why I am going more and more in this direction.
I have had almost a similar scenario as you described above under the classic 1%. However, I always look for at least some positive cash flow. Lucky me, rapid appreciation and also rent increases have gone to the roof in the recent years, so cash flow is now adequate for that particular property I purchased for +250K and now renting for $2.5K. That will not always be the case thought. For the long run, I care more about cash flow. Appreciation will be a very good thing to have and to pull money out and reinvest, but if you are not doing that and its not your strategy, then money is stuck with the property, you are not generating any add income and will be hard for most to grow.
- Rental Property Investor · Red Bank, NJ · Member since 2017 · 1k+ posts · 1k+ votes4y
I prefer cash in my pocket to equity. My kid's tuitions is in cash, not equity. As is my home mortgage... and bills... toys...
I am far too good of a landlord to put off being paid for years, if then! I want to get paid handsomely- but I am willing to take it on a monthly basis.
My market real estate prices have sky-rocketed in the last 2 years. There was absolutely no talent that went into it, just a confluence of events. Loser with a clapboard shack increased his equity...
That would make me very nervous if I was running victory laps and patting myself on the back because of equity.
- Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes4y
@Josue Vargas sweet deal, that is a lot of rent!! With interest rates as low as they are you actually don't need 1% to see positive cash flow, especially at higher price points tha math still works. And you are right about untapped equity - it's useless and wasted.
But here is the big difference, income is taxed and equity is tax free when you pull it out.
The other consideration is when you start mixing higher price assets into your portfolio then you are creating a tax shelter. The property I just bought provides over $9,000 in tax depreciation over the next 27.5 years. That helps offset income from other properties.
@Patrick M. and you should! Using cash flow to supprt your family life today instead of deferring that to "someday" is a very worthy use! Or to Axel's point reinvest cash flow, so your houses have babies and the portfolio grows without further W2 injections from your heavily taxed paycheck.
My point is to find the right balance between cash flow and equity, and that balance is different for everyone. And you have to consider it in the context of your portfolio, which means the goals change as your portfolio grows. Once you have met your cash flow needs, maybe double, you can re-assess your next goals.
Appreciation is never guranteed, even it looks like it is right now, unexpected things can happen. So you need to have overall strong cash flow, so you can weather a storm, survive on 70% occupancy etc. But you are building equity even without appreciation through your monthly principal pay down, about 3% pa and if you are leveraged 4:1 or 5:1 that's pretty good ROI on your down payment. You can use the equity (tax free income when liquidated) to buy more properties!
When you are able to combine your talent as an investor, your skills as a landlord with the above, great things happen. The loser with the clapboard shack will not run victory laps for very long.
- Real Estate Agent · San Antonio, TX · Member since 2017 · 814 posts · 466 votes4y
Originally posted by @Marcus Auerbach:
@Josue Vargas sweet deal, that is a lot of rent!! With interest rates as low as they are you actually don't need 1% to see positive cash flow, especially at higher price points tha math still works. And you are right about untapped equity - it's useless and wasted.
But here is the big difference, income is taxed and equity is tax free when you pull it out.
The other consideration is when you start mixing higher price assets into your portfolio then you are creating a tax shelter. The property I just bought provides over $9,000 in tax depreciation over the next 27.5 years. That helps offset income from other properties.
@Patrick M. and you should! Using cash flow to supprt your family life today instead of deferring that to "someday" is a very worthy use! Or to Axel's point reinvest cash flow, so your houses have babies and the portfolio grows without further W2 injections from your heavily taxed paycheck.
My point is to find the right balance between cash flow and equity, and that balance is different for everyone. And you have to consider it in the context of your portfolio, which means the goals change as your portfolio grows. Once you have met your cash flow needs, maybe double, you can re-assess your next goals.
Appreciation is never guranteed, even it looks like it is right now, unexpected things can happen. So you need to have overall strong cash flow, so you can weather a storm, survive on 70% occupancy etc. But you are building equity even without appreciation through your monthly principal pay down, about 3% pa and if you are leveraged 4:1 or 5:1 that's pretty good ROI on your down payment. You can use the equity (tax free income when liquidated) to buy more properties!
When you are able to combine your talent as an investor, your skills as a landlord with the above, great things happen. The loser with the clapboard shack will not run victory laps for very long.
I'm positive you know this, but for the audience here that may not be aware of some things to consider...
Only the additions to the land can be depreciated, not the land itself, and that's a chunk of the property taxes, at least where I live in Texas. Take in consideration if you eventually sell the property between the 27.5 yrs while depreciating or after (commercial are set to 29 yrs) and you don't use the 1031 exchange and reinvest, you will still owe taxes based on depreciation capture, meaning pay back taxes on savings you made based on depreciation on previous years! I always depreciate my properties and is a huge tax benefit.Keep it up! Looks like you know what you are doing! Good luck!
- Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes4y
@Josue Vargas - yes good point: only the improvements can be written off. Land value is usually a relativley small portion of the assessed value in Wisconsin, without looking I'd say on average 70% or more are improvements. All your capex goes into that bucket too.
We sometimes keep some of the landscaping work until next spring, this way we can expense it in the current tax year - as opposed to spreading it out over 27.5.
I am also not a huge fan of cost segregation for the same reason, which is popular amongst some MF investors, because while it boosts your short term write offs, it kind of forces you down the 1031 path so you can keep kicking the tax can down the road. And there is a drawback to 1031 nobody is talking about - you'll typically overpay on your exchange property, because you loose a lot of your negotiation power.
This is another reason to buy quality properties in quality neighborhoods, so you can refi them instead of selling and pull equity out tax fee - the single best tax strategy I know of!
Originally posted by @Axel Meierhoefer:
@Marcus Auerbach I wonder if you assume that the cash flow from cash flow properties an investor owns goes into consumption by the investor? I always suggest it should be used for accumulation and then reinvestment into more properties.
When you say: It's very hard to earn a million through cash flow (or at least it takes a long time). It's much easier to generate a million in equity. I always advocate for finding the right balance between the two.
it appears that you would not use cash flow for accumulation and reuse.An important part of the appreciation is market-driven, so having two properties in similar markets, one having cash flow and the other doesn't, anybody would favor the latter.
Even in a market where one has only appreciation and zero or negative cash flow and the other has mainly cash flow and no appreciation, I believe the use of the cash flow is important.
If I buy 2x $150K properties in cash-flowing markets versus the $300K property you mentioned and cash flow $500/month in each, I can buy the third $150K property about 30 months later (assuming no rent increases, etc.).
Another 18 months later I can buy the next (to have 4), another 15 months later the next to have 5, then a year later another one to have 6, another 9 months later the next to have 7, and again 9 months later the 8th.
That means in about 8 years I have $1+ million in asset value (assuming none of my $150K properties ever had any gains in equity) and make $4000/month in cash flow (assuming I never increase the rent even $1 in 8 years).
Is 8 years a long time? Maybe. Will you have generated enough equity to pay you at least $4000/month forever in less time?
I think you have the right mindset. However I do see a lot of posts here in this forum from other folks that would suggest otherwise. Many people talk about how cash flow 'pays my bills' or 'pays for my child's education'. I don't think there is anything wrong with that. Folks invest for different reasons.
I personally save every penny that comes from my rental properties, but I can also tell you without any uncertainty that I'd be a richer person today if I would have set up my investments for less cash flow.
- Real Estate Broker · Madison, WI · Member since 2015 · 118 posts · 60 votes4y
I know the point has been made before as well, but if you have long term fixed rate debt, and the market sees rental increases (even if just at rate of inflation) cash flow should increase over the years as well, although variable expenses will increase along with the rental income (taxes, utility rates, etc), but eventually the loan payment will look smaller and smaller based on increasing rental income, so a break even today could look like a great investment in 10 years.
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