(-) cash flow properties have me wondering - what am I missing?
Member since 2021 · 14 posts · 35 votes
New to real estate and looking for my first rental. Have been using the rental calculator on every potential property I find in Waukesha, Wisconsin and surrounding towns. Every single property is a bust! Negative cash flow properties have me wondering - what am I missing? Are these properties over priced, rents too low, taxes too high... Any help would be appreciated.
Cash flow
@Derek Peruo You are right, the margins can be higher for short-term rentals. Nevertheless, those crunching the numbers for a STR need to take into consideration the longer term depreciation schedule. You must use 39 years instead of the typical 27.5 for a residential rental. If you miss this, you can be a target for an IRS audit and many tax pros are missing this. On the other hand, a cost seg study can give you extra cash-flow upfront no matter if it is a short-term or long-term rental. This can give you the extra cash-flow to upgrade the unit(s) and increase the rent.
Bonie, help me understand the "cost seg study can give you extra cash-flow upfront" - the cost seg provides an acceleration to the depreciation deductions, not necessarily tax savings. You'll deduct more in the front years and less in the later years - and it's a deduction, which means you need to have the income, the cash flow in order to save more from taxes. No cash flow, nothing to deduct that year either. Yes, you'll not lose it, it will accumulate and you'll be able to deduct it when you'll have the income. But also, it will have to be recovered if and when you sell the property (unless your exit strategy is to die and pass it as inheritance, or 1031 exchange, and both if there are no changes to the legislation governing).
Now, it might give you a boost if you have several properties that produce income and help you offset some of that. But if you have one property, and the property has little to no cash flow, a cost seg will not help you create it. Correct me if I'm wrong.
Very easy to make every deal (even a good one) look like cash flow negative - all you have to do is change every single parameter a little bit to the conservative side! The cummulative effect (lower rents, higher vacancies, a bit higher expenses, PM fees etc, will be enough to make a good deal look like cash flow negative. or the other way, make a bad deal look like it could work. I am sure you have heard of the expression: garbage in, garbage out. So the trick is to not use pessimistic or optimistic numbers, but realistic ones.
New investors are often very concerned to calculate cash flow accuratly (how much exactly for lawn mowing?), but they just budget a small percentage of rent ('someone on BP said 5% is good") to cover all capex without much consideration, which can really range anywhere from almost nothing to six figures on a small multi. This is what really makes or breakes a deal. Future capex needs to be estimated/calculated for every individual property!
Property values have been going up faster than rents over the last 3 years in the Milwaukee metro area - last year rents grew 1.5% and median sales price per MLS +10.26%. (all the details and stats on my Milwaukee YouTube channel, link on the BP profile page). So, yes it is getting tougher every year.
Also keep in mind, you don't need to make all your profit on your first deal, the main thing is to get started. Smaller ROI is okay, as long as you keep it low risk, never risk your principal!
Marcus,
Here is my thought since this is a recurring theme in many markets and with most BP beginner landlords.. they are simply using the wrong math.. they are under the impression its not a deal if it does not cash flow with ONLY 20% down .. well you might have to put a little more down to get cash flow so maybe the metric is now for our current environment 30% down or 40% down is the norm and the number you use in your handy dandy number crunching cash flow calculator put those numbers in and see where you end up.. Now all of a sudden the deals work. There is no rule that says its ONLY a great deal if it cash flows with 20% down.. that's the break in the model and the mind set ..
I personally look at what is the COC if I paid cash.. then work backwards..
For now the formula is broken.
Except, that by increasing the cash out of pocket (DP) you are increasing the cost of the property to the REI and decreasing the CoCR, as well as lengthening the time it takes to recover your cost (DP) and thus start making a profit.
Here's an example of what I'm saying: Given
Purchase Price of Property = $200k
Cash Flow before Mortgage Payment is added to expenses = 1440/M
Option #1: 20% DP = $40k; Loan (30 yr) = $160k
Cash Flow after Mortgage Payment is added to expenses = 500/M; 6000/yr
Years to recover cost (DP) = 6 years, 8 months
Option #2: 30% DP = $60k; Loan (30 yr) = $140k
Cash Flow after Mortgage Payment is added to expenses = 610/M; 7320/yr
Years to recover cost (DP) = 8 years, 2 months
Now I've seen it all on BP, someone who started in RE when Carter was in office having the basics of leverage explained to them like they are ten.
Joe, lets say you have $60k and go with the 20% down option, what's the CoC of the $20k that's not getting invested?
@Derek Peruo You are right, the margins can be higher for short-term rentals. Nevertheless, those crunching the numbers for a STR need to take into consideration the longer term depreciation schedule. You must use 39 years instead of the typical 27.5 for a residential rental. If you miss this, you can be a target for an IRS audit and many tax pros are missing this. On the other hand, a cost seg study can give you extra cash-flow upfront no matter if it is a short-term or long-term rental. This can give you the extra cash-flow to upgrade the unit(s) and increase the rent.
Bonie, help me understand the "cost seg study can give you extra cash-flow upfront" - the cost seg provides an acceleration to the depreciation deductions, not necessarily tax savings. You'll deduct more in the front years and less in the later years - and it's a deduction, which means you need to have the income, the cash flow in order to save more from taxes. No cash flow, nothing to deduct that year either. Yes, you'll not lose it, it will accumulate and you'll be able to deduct it when you'll have the income. But also, it will have to be recovered if and when you sell the property (unless your exit strategy is to die and pass it as inheritance, or 1031 exchange, and both if there are no changes to the legislation governing).
Now, it might give you a boost if you have several properties that produce income and help you offset some of that. But if you have one property, and the property has little to no cash flow, a cost seg will not help you create it. Correct me if I'm wrong.
In general I agree, but could think of 2 cases where you would be wrong (not an accountant, so verify with your accountant):
Good luck
@Costin I. You are correct in that if you have no income, it is unlikely that cost segregation will be of benefit to you with a few exceptions. Under the Cares Act, if you are a RE Professional or an owner/occupant (i.e., restaurant, doctor owning his own building, manufacturing facility, etc.), you can use cost segregation's big NOLs to get a refund from the IRS on previous years' taxes when you did pay taxes.
If any commercial or residential RE investor can't use all the benefits in the first year of doing the study, they can push them forward to years going forward. You also asked about my reference to "cash flow upfront". If you don't have to pay state & federal taxes, that gives you cash upfront that is available to re-invest or use as you prefer. And, it is usually 6% to10% of what you paid for the property in after-tax cash flow. Think of it like winning the lottery, do you want cash upfront or dribbled to you over years and years? Why let the IRS hold that money, when you can reinvest it at much higher returns.
You also mentioned "recapture" upon sale. It is not likely that the carpeting, as an example, is going to be worth what it was valued at when the study was done. A sharp CPA/tax professional knows that he/she can easily justify a decrease in value of the tangible property upon sale. And, upon sale, the value of the dollar will be lower...think "time value of money". Even the American Institute of CPAs (AICPA) recommends doing cost segregation studies on all properties purchased for $750k or more. We do them on properties from $200k up to about $2 billion.
I hope this answers your questions. I am available to discuss in more detail if you want to contact me directly.
@Dan H. An investor does not have to be a RE Professional to benefit with a cost segregation study on a property. As long as the property or a group of passive commercial or residential properties is showing an income sufficient to have to pay federal + state taxes, it is well worth getting an engineering-based estimate. Passive losses on RE can be used against passive gains on other investments.
On another point you made, yes, as a RE Professional your tax benefits can be used to offset non-investment income. Also, an owner/occupant who has grouped their building with their practice/business can use the NOLs from cost seg against their business income.
@Dan H. An investor does not have to be a RE Professional to benefit with a cost segregation study on a property. As long as the property or a group of passive commercial or residential properties is showing an income sufficient to have to pay federal + state taxes, it is well worth getting an engineering-based estimate. Passive losses on RE can be used against passive gains on other investments.
On another point you made, yes, as a RE Professional your tax benefits can be used to offset non-investment income. Also, an owner/occupant who has grouped their building with their practice/business can use the NOLs from cost seg against their business income.
It was my belief that @Costin I. was discussing the case where the RE write offs exceeds the RE income (i.e. where there is not much cash flow). You are correct, if there is income above the deductions (which there should be), then there is no issue writing off everything without being a RE professional or having lower income (income below the threshold).
If the RE income is less than the deductions, the deductions can be used to offset non-investment income if the taxable income is below some level or you qualify as an RE professional. Otherwise, the excess deductions gets banked against future investment income.
I believe we are in agreement, but maybe I was not clear in my response that I was referring to the case where Costin was indicating the RE deductions exceed the RE income (the low cash flow case).
Very easy to make every deal (even a good one) look like cash flow negative - all you have to do is change every single parameter a little bit to the conservative side! The cummulative effect (lower rents, higher vacancies, a bit higher expenses, PM fees etc, will be enough to make a good deal look like cash flow negative. or the other way, make a bad deal look like it could work. I am sure you have heard of the expression: garbage in, garbage out. So the trick is to not use pessimistic or optimistic numbers, but realistic ones.
New investors are often very concerned to calculate cash flow accuratly (how much exactly for lawn mowing?), but they just budget a small percentage of rent ('someone on BP said 5% is good") to cover all capex without much consideration, which can really range anywhere from almost nothing to six figures on a small multi. This is what really makes or breakes a deal. Future capex needs to be estimated/calculated for every individual property!
Property values have been going up faster than rents over the last 3 years in the Milwaukee metro area - last year rents grew 1.5% and median sales price per MLS +10.26%. (all the details and stats on my Milwaukee YouTube channel, link on the BP profile page). So, yes it is getting tougher every year.
Also keep in mind, you don't need to make all your profit on your first deal, the main thing is to get started. Smaller ROI is okay, as long as you keep it low risk, never risk your principal!
Marcus,
Here is my thought since this is a recurring theme in many markets and with most BP beginner landlords.. they are simply using the wrong math.. they are under the impression its not a deal if it does not cash flow with ONLY 20% down .. well you might have to put a little more down to get cash flow so maybe the metric is now for our current environment 30% down or 40% down is the norm and the number you use in your handy dandy number crunching cash flow calculator put those numbers in and see where you end up.. Now all of a sudden the deals work. There is no rule that says its ONLY a great deal if it cash flows with 20% down.. that's the break in the model and the mind set ..
I personally look at what is the COC if I paid cash.. then work backwards..
For now the formula is broken.
Except, that by increasing the cash out of pocket (DP) you are increasing the cost of the property to the REI and decreasing the CoCR, as well as lengthening the time it takes to recover your cost (DP) and thus start making a profit.
Here's an example of what I'm saying: Given
Purchase Price of Property = $200k
Cash Flow before Mortgage Payment is added to expenses = 1440/M
Option #1: 20% DP = $40k; Loan (30 yr) = $160k
Cash Flow after Mortgage Payment is added to expenses = 500/M; 6000/yr
Years to recover cost (DP) = 6 years, 8 months
Option #2: 30% DP = $60k; Loan (30 yr) = $140k
Cash Flow after Mortgage Payment is added to expenses = 610/M; 7320/yr
Years to recover cost (DP) = 8 years, 2 months
Now I've seen it all on BP, someone who started in RE when Carter was in office having the basics of leverage explained to them like they are ten.
Joe, lets say you have $60k and go with the 20% down option, what's the CoC of the $20k that's not getting invested?
What $20k in cash not invested? You would use the $60k as a 20% DP on $300k worth of properties.
@Jennifer Walsh I would start with how are you finding these properties? (mls, wholesalers, driving-for-dollars, direct mail). If it's the mls, it could be that there aren't any deals there. Although, I have a colleague, @Sean Rooks, who's been killing it in mls deal sourcing when others say they can't find anything. If it's wholesalers, then they need some guidance about what makes a good deal for their end-buyer. I'm assuming you're not driving-for-dollars or direct mail. Those options might be worth looking into.
The next thing I would look at is how you're analyzing the deals. Where are you getting your numbers? @Marcus Auerbach has some good points on this topic. Are you estimating repairs accurately? Are you accounting for everything (CAPEX, Vacancy, Repairs, Management)? Unlike @Ben Miller, all of my properties are professionally managed, and I believe you should budget for management even if you're doing it yourself. Are you overestimating any of these? @Andrew Adam makes a great point about that.
@Nathan Gesner makes a very good point. There are some markets that appreciate strongly while others stagnate, and there are some that cashflow very well, while others don't. Many times the high appreciation markets don't cashflow while the high cashflow markets don't appreciate well. Sometimes you're lucky and live in an area that has spots of both cases.
@Kevin Rea seems to have a pretty good grasp on the area, but there are many ways to find deals. Sounds like you need to look into generating your own.
And lastly, @Jay Hinrichs makes a very good point that, in some markets, an investor will need to leave some money in the deal. It's all about ROI in the end, and in this business Cash-on-cash is king.
Happy investing!
Hey Guys! (Wisconsin slang for everyone of you)
First, I have to thank all of you for the wise words! Its nice knowing there's a community on here that understands and can help lead us newbies!
Just like that I found a property! and it CASH FLOWS!!! I ended up paying cash for it and will do a cash out refi once I find my next deal.
I saw the property while on a walk it was for rent. The next day shows up on MLS. Went for a tour and made offer that day. The property is 3 blocks from my home, so easy to manage. The area is very nice, close to a STEM grade school, college, downtown, parks, brand new community pool and the list goes on. The property has so many new CapEx items (windows, driveway, new garage, water heater, boiler, roof 15yr old). I know this will be an easy starter rental for me and my husband. The CoC ROI is at 7% I know not much better than the stock market, but I'm hopeful this will be a great property to have in our growing portfolio!
Thank you again!
Jen from Waukesha, WI
Congratulations @Jennifer Walsh we live and invest in Waukesha county. Always love to connect with local investors.
@Joe Villeneuve Sure in an academic sense that answer fits, but reality is slightly different. RE isn't fractional.
In your example the house cost $200k. If you had $60k in the bank you have two choices. 1. put $60k down, accept the lower ROI and move on 2. Put $40k down getting the high ROI, leave $20k in the bank getting 1%ish at best, and wait until you find another property that meets your investing criteria. Now if have a super deal pipeline where you get lots of looks at properties that may be a good call, since you can move the $20k to another investment.
However if you don't have the pipeline and are competing for deals, that cash could sit in the bank for a long time bringing down your overall return.
@Joe Villeneuve Sure in an academic sense that answer fits, but reality is slightly different. RE isn't fractional.
In your example the house cost $200k. If you had $60k in the bank you have two choices. 1. put $60k down, accept the lower ROI and move on 2. Put $40k down getting the high ROI, leave $20k in the bank getting 1%ish at best, and wait until you find another property that meets your investing criteria. Now if have a super deal pipeline where you get lots of looks at properties that may be a good call, since you can move the $20k to another investment.
However if you don't have the pipeline and are competing for deals, that cash could sit in the bank for a long time bringing down your overall return.
...or, you learn how to look for markets instead of properties, and you find that "fractional" REI does exist.
I don't look for properties, I look for markets. The markets are made up of properties, thus when I look for markets, I find multiple properties. I believe in looking for "stacks of needles", instead of needles in haystacks.
I get frustrated every time I read on BP someone saying they just closed on a deal, and...now what do I do"? They should know that before they made the current deal. Each deal you make should setup the next deal. Each deal is defined in your plan, and executed within the market(s) you have found using whatever strategy you need to use where the deal (property) delivers the criteria defined in your plan.
Not having that plan, is why most REI run into trouble/roadblocks, and not analyzing for markets is why most REI make bad deals...they don't know where the next one is coming from, so they rationalize the current deal to make it fit.
congrats! @Jennifer Walsh I live in Pewaukee and invest in waukesha as well