Would you buy a rental property with negative cash flow?
Investor · East Earl, PA · Member since 2016 · 12 posts · 6 votes
Would you buy a property with negative cash flow?
My husband and I want to invest in a townhouse that we plan on selling once the mortgage is paid in full. We could have the mortgage for 30 years, but we are choosing on having a 15 year fixed mortgage instead, to save on interest and to be able to re sale it once we retire. The price is $175,000. We have the down payment and closing costs covered. Our interest rate would be 4.5% (investment property)
Our plan is to pay the mortgage with the rental income which is estimated in $1200 currently, I do not doubt this could be increased with time.
After adding all expenses we will be short $250 each month, that includes interest, taxes, insurance, HOA, and vacancy/repairs expenses. The property was built in 2006 and is in good shape. We will be able to rent it as soon as we get the keys.
The property is located in a nice area with constant rentals demand, so we count on having it rented with no problems most of the time. Also we believe it will appreciate over time.
This will not affect our finances since we have other income sources, we are looking at it as a long term investment.
TIA for your kindness.
You can get a 30 year mortgage and make extra principal payments rather than getting a 15 year mortgage and having negative cash flow...provides more flexibility.
I can argue against accelerating the debt pay down but that's a topic for a different post.
I started investing in real estate 11 years ago. I started with 30 year notes but transitioned to 15 year notes a couple years in for a variety of reasons. I want to make the same return that most folks shoot for on a 30 year note on my 15 year notes. That narrows my focus. I have been focusing on my construction business since retiring from my w-2 job this spring as the sole provider of my family of 4. Over the last couple years, I keep my eyes open but am not dying to find deals. However when I see something that works, I jump. I do not mind sitting on a pile of cash while prices are causing margins to compress. Last fall I bought a nice duplex close to home, made an aggessive offer in a competitive market and it happened to work out with the motivated sellers. I just wrapped up a wholesale purchase details the other day and will close on the 1st. It has been much wiser foe me to be patient and ready to act when the right deal comes along.
If the HOA due is reasonable and healthy(no anticipated increase), it sounds like a reasonable investment. You will do well after next rental increase and can even pay off early so eventually you have a solid fixed income.
No...life is too short...
Congratulation on your investment!
We had same thought when we purchased our new town home, to go with 15 years and pay off sooner. However we went with 30 years to make sure we have positive cash flow and to make sure we have enough left to cover the market down turn and vacancies/major repair. Currently, I am paying extra Principal since I can afford to at the moment, but have flexibility to stop when necessary.
Good luck with your investment.
What are your goals @patricia luna ? If you’re buying for appreciation, need a tax shelter etc, then maybe.
I personally was in this scenario and I discuss it more in my blog titled “How I Started Investing in Real Edtste”. Once I figured out my goal was cash flow I dumped my Property that was costing me $300/month. I could never justify making the $3,600/yr back as this would require this particular Property to appreciate 3.5% year over year. That wasn’t going to happen for me, maybe it will for you, but ultimately I believe it starts with identifying goals.
Looking at goals and the situation (property is hard to find, pros of a new house) it may be a good idea. I own a newer house using a 15-year with bi-weekly payments (1 extra payment per year to pay off in 12). Lived there a while, then rented for same as PITI is, so on paper it looks like neg cash flow. Then did again in our current house. Getting ready to do it a 3rd time. All houses will be paid for in less than 15 years, which is when I retire. Altogether, all 3 new houses will cost me in cash (5% down loans plus closing) about $40-45K total. I don't anticipate major expenses but it could happen. Husband is a contractor should something come up. Anyway, the 3 rentals will net $48K a year when I retire. I would need over $900,000 in cash/stocks to get that any other way, pulling out 4% a year and hoping for no stock market crashes. Most rental homes available are older without upgrades, and landlords deal with problem tenants. These houses have HW floors, stainless, granite, etc and attract great tenants with waiting lists. For me, this works. For you Patricia, you can afford the neg cash flow, it will be a tax write-off, plus you can borrow against the equity if you need to, or easily sell it. I would do it.
This is pretty funny given what's going on around here, people are investing in $250k-$1m condos, and losing money every month in a market rising double digits annually. There's more than one way to play this game. We haven't seen 1% deals around here in years.
This is the way I look at it. If I buy a property 25% down on a 15 year that breaks even after everything, after 15 years I've made 9.4% if the property stays the same value and rents don't rise. That's a pretty good return. But those things usually do rise, so the property that starts out no cashflow eventually gets there, like my 2004 purchase, and the return only goes up from there :) It's up probably 75% from purchase price in a hot gentrifying area (100% according to Zillow) and rents have gone from $3000 to $4750. Had I nixed it for no cashflow I'd have missed a huge opportunity.
Can this work out in theory? Yes.
I sort of accidentally ended up doing this with my rental property after I got married and rented out my home. I treated it as a college savings plan, so I didn't sweat negative cash flow. It worked out since it is paid off now while my kids are still in high school, has more than doubled in value (about 135% of what I paid), and is now providing a good revenue stream.
Why I prefer this to a regular 529 plan is that instead of just putting money into a investment account and then spending it, I will still have a property that will provide income after my kids finish school.
Thank you all for your feedback, I really appreciate it. I will give you an update once I make a decision.
it depends on just a few key things
1. do you seriously anticipate this property appreciating pretty well over the next 5-10 years? if so, then absolutely its worth it
2. i believe youre overpaying for this property at 175,000. i know i havent seen it yet, but it seems like youre overpaying. this better be a badass 4/3 luxury condo or something, but if it were, youd be able to charge higher than 1200/month
3. before you make this move, take a step back and consider a deal that is simply WAY BETTER that might be hidden away fro your "radar" during all this time. this deal seems like its marginal or slightly better than marginal. why settle for marginal when you could knock it out of the park?
@Patricia Luna, what did you end up doing?
I am in a similar situation with an existing home purchased in Sacramento in 2010. 170k FHA purchase, worth 320k now. I cash-out refi'd to purchase our primary residence after I got married, so my loan is at 220k now.
If I turn it into a rental, I could break even or cash flow positive ~$1-200 month (all considering). However, it will need a new roof in the near future.
I have a couple options:
1) Cash out refi to take the last remaining equity out (10k for roof + 25k cash) and rent/hold long term. I have tenants set up already should this be the case. 30 year loan will leave me net negative ~$200/month.
2) Sell (net $25-30k cash after taxes).
I do not need the cash. I understand we may be at the top of our market cycle, but in California, long term I see the market going up. I feel like I am paying a ton of capital gains for cash that I do not need. Also if I look at it from the opposite perspective, it is almost impossible to find an investment SFH in California for $25-30k down, so this may be my only opportunity at accumulating real estate and eventually passive income.
I am 30 years old, looking to leverage my opportunities as much as possible. Leaning heavily towards making it a rental. This also gives me an opportunity to 1031 transfer the property to a southern CA rental (where I live) after a couple years to defer taxes down the line if the rental doesn't work out. Currently, at 1031 is not an option as I have never claimed rental income on my taxes.
Any input would be appreciated. Thanks in advance.
Russell: Your "Return on Equity" in California is quite poor when compared to other markets. Given your two options: 1) creating a negative annuity or 2) selling the property ... I'd sell!
It really depends on the area that this property is located in. Take a close look at the rental rates surrounding you and determine if it is renting under market value.
If it is, you may want to look into some cheap and affective ways that you can force appreciate the property and increase the rents.
There are many ways you can do this by touching up the appearance of the exterior & interior:
• A new coat of paint throughout the house (bright colors)
• Smart locks
• Smart thermostats
• A little TLC to the landscaping
Russell: Your "Return on Equity" in California is quite poor when compared to other markets. Given your two options: 1) creating a negative annuity or 2) selling the property ... I'd sell!
Thanks for the reply. Negative cash flow short term yes, but I'm not really looking for small cash flow. Won't change my day to day. I just can't get over throwing away equity to capital gains. And figure mortgage pay down + potential appreciation may make it worth it? Like forced savings or the 529 example from another poster above. Turned out well for her.
Plus the refi gives me liquid equity now rather than waiting the 15-20 years when it's paid off. If I didn't pull the equity, it would be cash flow neutral or positive.
I'd be gambling I guess. But thanks for your input. Hoping to hear more if anyone's out there. If I'm way off base with my logic please put me in check.
Russell: Your "Return on Equity" in California is quite poor when compared to other markets. Given your two options: 1) creating a negative annuity or 2) selling the property ... I'd sell!
Thanks for the reply. Negative cash flow short term yes, but I'm not really looking for small cash flow. Won't change my day to day. I just can't get over throwing away equity to capital gains. And figure mortgage pay down + potential appreciation may make it worth it? Like forced savings or the 529 example from another poster above. Turned out well for her.
Plus the refi gives me liquid equity now rather than waiting the 15-20 years when it's paid off. If I didn't pull the equity, it would be cash flow neutral or positive.
I'd be gambling I guess. But thanks for your input. Hoping to hear more if anyone's out there. If I'm way off base with my logic please put me in check.
While I would be open to negative cashflow under certain circumstances, I would not do the deal that you're planning on doing.
For one thing, getting a 15 year mortgage doesn't help you. You can take a 30 year mortgage and just add an extra check every month, towards equity. That also saves you on interest and you get to pay your mortgage off faster. But you're not tied to the higher payment of the 15 year mortgage, as there might be months, when you'd rather pay less.
Doesn't sound like an area that has some major developments to push prices up quickly, but rather a slow hope of 'real estate goes up after time'. That's not a good move.
Have you included vacancy, repairs etc? If you're negative without including those, this will just be an alligator, that you'll have to keep feeding every month. Not a deal, in my opinion.
Russell: Your "Return on Equity" in California is quite poor when compared to other markets. Given your two options: 1) creating a negative annuity or 2) selling the property ... I'd sell!
Thanks for the reply. Negative cash flow short term yes, but I'm not really looking for small cash flow. Won't change my day to day. I just can't get over throwing away equity to capital gains. And figure mortgage pay down + potential appreciation may make it worth it? Like forced savings or the 529 example from another poster above. Turned out well for her.
Plus the refi gives me liquid equity now rather than waiting the 15-20 years when it's paid off. If I didn't pull the equity, it would be cash flow neutral or positive.
I'd be gambling I guess. But thanks for your input. Hoping to hear more if anyone's out there. If I'm way off base with my logic please put me in check.
Thanks for the reply. It's east of the 99 in Vineyard area. Was technically a parent occupied second home past few years. So can't get the 2 of 5 year principle residence loophole.