How much negative cashflow is tolerable?

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How much negative cashflow is tolerable?

Allen Scoging
Member since 2020 · 11 posts · 3 votes

The obvious answer is zero - it's a suicidal strategy! But, here's the full story:

I live in SoCal and currently rent but have a down payment saved and ready to buy. Unfortunately, property prices are currently detached from reality and competition is insane. It doesn't seem like a prudent move to knowingly pay over the odds just too seal a deal for a SFH. However, when my rent is almost as high as a mortgage payment, and I have a down payment saved, I can't see a reason not to buy, despite the record high prices.

I can either spend a lot for a SFH, or spend only a bit more for a duplex which I'd house hack. This would effectively give me 2 properties (units) at a much lower unit cost than I could purchase a SFH, or even two apartments/condos - with the benefit that someone else was (mostly) paying for the 2nd unit. Additionally, buying a duplex would mean I get to live in neighborhood I otherwise couldn't afford to live in. On top of that, there are the tax savings (deduct mortgage interest & property tax, depreciate 2nd unit, etc.)

If I can get hold of a duplex, I've run various scenarios through the BP calculators and the numbers never add up to be a good investment - they won't cash flow, CoC is dire etc. I've often heard people say, the California market is different, you wouldn't expect great cash flow or returns, and the investment is more about long term capital growth, in which case the conventional calculators are less applicable.

Can anyone suggest how I should analyze such a proposition to ensure I'm not committing financial suicide? As the post title suggests I'd be running a negative cashflow if the conventional assumptions are applied (% for vacancy, repairs, capex and so on). Is several hundred dollars OK? Any rules of thumb - a percentage of the price/rent? Some of my other posts have various scenarios for actual numbers I've modeled. 

Thanks!

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Bill F.
Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes
5y

@Allen Scoging

Are you taking into account your own housing expense? Right now you re losing 100% of your money to rent. Say for instance you pay $2k/month in rent currently. That is your benchmark. If you can get a duplex where you have to cover $1k/month yourself, you have achieved a 50% savings. 

When you run the numbers on the duplex are expecting the duplex to be cash flow positive when you live in one unit or are you running the numbers with both units at market rent? If it is later case, what rent growth are you factoring in?  

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  • Bill F.
    Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes
    5y

    @Allen Scoging

    Are you taking into account your own housing expense? Right now you re losing 100% of your money to rent. Say for instance you pay $2k/month in rent currently. That is your benchmark. If you can get a duplex where you have to cover $1k/month yourself, you have achieved a 50% savings. 

    When you run the numbers on the duplex are expecting the duplex to be cash flow positive when you live in one unit or are you running the numbers with both units at market rent? If it is later case, what rent growth are you factoring in?  

    3Reply
  • Todd Rasmussen
    Rental Property Investor · Clarksville, TN · Member since 2016 · 1k+ posts · 1k+ votes
    5y

    @Allen Scoging

    The more property you can buy now, the more wealth you have later. Unfortunately, cash flow negative investments are not sustainable, so your decision really becomes one of, how much negative cash flow can you support.

    You have to assume a lot of variables for these types of calculations but in general:

    [(Purchase price of duplex x % appreciation x years owned) - (closing costs from purchase and sale) - expected cumulative negative cash flow + expected tax benefits + equity from principal paydown] - [theoretical investment with cash on hand now plus monthly reinvestments of negative cash flow above for the same time period you us for years owned - expected taxes from theoretical investment]

    That exercise will give you the return or cost of your decision to house hack. I think you'd be better off living outside of the area you want to and buying a four unit for better diversification in a state with CA's landlord experience and a better chance of starting to break even sooner. Once you save up another down payment, then you can buy the home you want to live in.

    The fact that you are also buying a primary residence makes this a very subjective decision that only you can really make....

    1Reply
  • Todd Rasmussen
    Rental Property Investor · Clarksville, TN · Member since 2016 · 1k+ posts · 1k+ votes
    5y
    Originally posted by @Bill F.:

    @Allen Scoging

    Are you taking into account your own housing expense? Right now you re losing 100% of your money to rent. Say for instance you pay $2k/month in rent currently. That is your benchmark. If you can get a duplex where you have to cover $1k/month yourself, you have achieved a 50% savings. 

    When you run the numbers on the duplex are expecting the duplex to be cash flow positive when you live in one unit or are you running the numbers with both units at market rent? If it is later case, what rent growth are you factoring in?  

    A significant amount of his mortgage payment, especially in the beginning will be to interest, which is an expense he doesn't have while renting. income from renting should offset expenses, but the amount he pays towards interest is still "lost" and shouldn't be looked at as savings.

    1Reply
  • Michael S.
    Huntsville, AL · Member since 2018 · 577 posts · 864 votes
    5y

    @Allen Scoging - the vast majority of properties we have bought have positive cash flow.  

    However, if you know your market well, negative cash flow can be tolerable to some extent - for example, when you get a killer deal in an A+ neighborhood.  We bought a house in 2018 that was a great price for the A+ neighborhood it was located in.  We had a negative cash flow of 75 / month the first lease year, but we knew it was an area that was too good of a deal to pass up, and we were forecasting the rent would catch up too.   Sure, there is risk here. . .but risk is inherent with any investment.   

    Fast forward to 2021 - it is now positive $100/month cash flow.  That's nice.  The house has appreciated 25% since we bought it.  Now that's a much bigger deal than the tiny cash flow variance.  

    So cash flow is definitely important...but it's not the only variable to analyze;  make sure to look at all the variables. 

    Also, to be honest, we do our cash flow analysis based on a 15 year amortization, not 30 years.  

    1Reply
  • Taylor L.
    Rental Property Investor · RVA · Member since 2016 · 5k+ posts · 4k+ votes
    5y

    IMO there are far too many cash flowing opportunities to justify speculating on the future of the CA real estate market. Now, if you're buying a duplex to live in half, the value system is a bit different. If your rent now is $2,500 and your monthly cost on a duplex are, say, $3,000, but you can rent one unit of that duplex at $2,000, then you effectively reduced your monthly costs by $1,500. It seems to me you're coming out way ahead in that made up case. Particularly if you plan on staying there for time. Beyond that, I would certainly not be buying investment properties there.

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  • Allen Scoging
    OP
    Member since 2020 · 11 posts · 3 votes
    5y

    Thanks for the replies so far.

    To give a bit more context, as it stands the current rents would cover mortgage, insurance (an estimate in my calcs) and property tax. There's nothing left over for repairs/maintenance etc. but I can use savings for any of that in the same way that I would if I just bought a SFH. I think the rents are a little below market rate and so the unit I'm not living in could be increased slightly which would make the sums a bit better.

    My concern is the current state of the market and how that diminishes the upside of the investment. Prices are record highs and if we're at the top of a cycle I could have to wait years if I need to exit. Also it would limit the capital gain I could make if I'm buying when it's expensive. 

    I'm conscious the one thing you can never change is the purchase price. This will also set the basis of the property tax, which is not insignificant (~$900/mo). I'm aware Prop 13 will limit the increase to 2% year, and also should property values fall, I could use Prop 8 to save some money temporarily. 

    Additionally, mortgage interest rates are at/were record lows so its unlikely I'll ever be able to refinance in the future at a lower rate. Therefore my mortgage payment is unlikely to ever go down. 

    If rents ever fall, I could be getting into a hole!

    All these concerns translate to the scenario of just buying a house to live in, so why not buy a duplex if I have the means and get that added leverage from someone else servicing half of my investment?   

    @Michael S. Valid points. Trouble is I don't know the market well, I'm a first time buyer! As mentioned above my concerns about buying in a high price environment makes seeing capital growth a much riskier proposition, and i think I need to be prepared to weather falling prices in the coming years. 

    @Taylor L. I hear what you're saying - In this case rents from each unit cover half of the mortgage/tax/insurance each, so I wont be living any cheaper. The value is that I'll be building equity in a property rather than paying rent. There's also the opportunity cost. I could buy a SFH with my funds and use the rest that I would have spent on upgrading to a duplex, on buying a cheaper cash flowing investment out of state. That could be a better proposition.

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  • Bill F.
    Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes
    5y
    Originally posted by @Todd Rasmussen:
    Originally posted by @Bill F.:

    @Allen Scoging

    Are you taking into account your own housing expense? Right now you re losing 100% of your money to rent. Say for instance you pay $2k/month in rent currently. That is your benchmark. If you can get a duplex where you have to cover $1k/month yourself, you have achieved a 50% savings. 

    When you run the numbers on the duplex are expecting the duplex to be cash flow positive when you live in one unit or are you running the numbers with both units at market rent? If it is later case, what rent growth are you factoring in?  

    A significant amount of his mortgage payment, especially in the beginning will be to interest, which is an expense he doesn't have while renting. income from renting should offset expenses, but the amount he pays towards interest is still "lost" and shouldn't be looked at as savings.

     Todd, you are 100% right about the mortgage payment, but I don't see what that has to do with the price of tea in China. 

    Right now he loses 100% of his monthly rent check to the landlord. If he buys a SFR 70% of his payments go to interest. If it goes to the landlord, the bank, or Santa Claus it doesn't make much difference, the money is lost. He is trying to minimize the percentage of money lost and basic math tells me .7<1.

    Now layer in the fact that I believe he is trying to house hack the duplex and the rents cover most of the mortgage, he has shifted a portion of the expenses to the tenant. 

    Discussions like this most often miss the concept of implied housing expense (IHE). We all have one, renters and homeowners alike. Right now since OP is renting, we have a pretty good idea what his IHE is. It seems like getting a duplex lowers his IHE in total without taking into account the amortization of the loan, which make the interest-principle ratio a point moot. 

    1Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    5y

    I suspect the properties you are looking at would cash flow just fine given a normal amount of leverage and suapect you will be using a higher amount of leverage thus causing negative cash flow.  The situation is completely independent of the properties fundamentals.

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  • Taylor L.
    Rental Property Investor · RVA · Member since 2016 · 5k+ posts · 4k+ votes
    5y
    Originally posted by @Allen Scoging:

    Thanks for the replies so far.

    To give a bit more context, as it stands the current rents would cover mortgage, insurance (an estimate in my calcs) and property tax. There's nothing left over for repairs/maintenance etc. but I can use savings for any of that in the same way that I would if I just bought a SFH. I think the rents are a little below market rate and so the unit I'm not living in could be increased slightly which would make the sums a bit better.

    My concern is the current state of the market and how that diminishes the upside of the investment. Prices are record highs and if we're at the top of a cycle I could have to wait years if I need to exit. Also it would limit the capital gain I could make if I'm buying when it's expensive. 

    I'm conscious the one thing you can never change is the purchase price. This will also set the basis of the property tax, which is not insignificant (~$900/mo). I'm aware Prop 13 will limit the increase to 2% year, and also should property values fall, I could use Prop 8 to save some money temporarily. 

    Additionally, mortgage interest rates are at/were record lows so its unlikely I'll ever be able to refinance in the future at a lower rate. Therefore my mortgage payment is unlikely to ever go down. 

    If rents ever fall, I could be getting into a hole!

    All these concerns translate to the scenario of just buying a house to live in, so why not buy a duplex if I have the means and get that added leverage from someone else servicing half of my investment?   

    @Michael S. Valid points. Trouble is I don't know the market well, I'm a first time buyer! As mentioned above my concerns about buying in a high price environment makes seeing capital growth a much riskier proposition, and i think I need to be prepared to weather falling prices in the coming years. 

    @Taylor L. I hear what you're saying - In this case rents from each unit cover half of the mortgage/tax/insurance each, so I wont be living any cheaper. The value is that I'll be building equity in a property rather than paying rent. There's also the opportunity cost. I could buy a SFH with my funds and use the rest that I would have spent on upgrading to a duplex, on buying a cheaper cash flowing investment out of state. That could be a better proposition.

     In that case it's more a question of how you'd prefer to invest. Personally, I would rather have property management working with my tenants, collecting rents, handling evictions, and invest in rentals in states other than California. You may also want to consider a short term rental house hack, where you have a place with an inlaw suite or some extra space that you rent out on Airbnb.

    0Reply
  • Chace Fraser
    Realtor · Portland, OR · Member since 2017 · 357 posts · 259 votes
    5y

    If you are using a low down payment option, it's not really realistic to expect to be cash flow positive while you’re house hacking and living in the property. However, if your house hack reduced your housing costs from $1,200 to $600 per month, would that not be a win? That would create an extra $600 per month of “cash flow” that you could save and invest in your next property. Keep in mind the property must cashflow after you move out for the deal to make sense (in most scenarios). When an investor is looking at being cash flow positive, they are typically putting down 20 percent or more. If you are in a high demand metro area, it's simply not realistic to expect to be cash flow positive if you are putting down 0-10%.

    Now if that is all the capital you have, that is what it is. Is it better to keep renting than to buy? Typically it is better to buy. Better to build your own equity through the debt paydown, enjoy the tax benefits of ownership, and garner the equity of an appreciating asset. You just can't expect to cash flow on an initial purchase with a low down payment. Now with time and rent growth, what could be a negative cash flow property might very well become a cash flow king, but that takes patience.

    Another way to increase cash flow would be renting out rooms in the unit you live in, either Airbnb or longer term.

    0Reply
  • Allen Scoging
    OP
    Member since 2020 · 11 posts · 3 votes
    5y

    @Russell Brazil Can you expand, please? (I'm a newbie) I'm planning on putting 20% down, I could cover the entire mortgage payment myself, although it would be a stretch to do it long term - too high % of my gross pay, for my comfort. Wouldn't that be normal leverage? 

    0Reply
  • Allen Scoging
    OP
    Member since 2020 · 11 posts · 3 votes
    5y

    @Chace Fraser Thanks for the reply Chace. I'm intending on putting 20% down, then the rent would cover mortgage, tax and insurance with nothing left over for maintenance, capex etc.  - that's when it becomes negative, putting aside the recommended amounts in the BP calculators. 

    In this case, house hacking would not reduce my direct housing costs as in your example. I would continue paying the same amount. Instead it would increase leverage. I would be paying the same amount of rent to myself, but I would be building equity in a property with 2 units. The rent from the second unit mostly takes care of 50% of the costs as above.

    0Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    5y
    Originally posted by @Allen Scoging:

    @Russell Brazil Can you expand, please? (I'm a newbie) I'm planning on putting 20% down, I could cover the entire mortgage payment myself, although it would be a stretch to do it long term - too high % of my gross pay, for my comfort. Wouldn't that be normal leverage? 

     Whats the purchase price and expected gross rents of the property?

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  • Allen Scoging
    OP
    Member since 2020 · 11 posts · 3 votes
    5y

    @Russell Brazil I'm basing it on $1.1MM purchase price and $5k gross rent from both units combined

    0Reply
  • Shankar Sridhar
    New to Real Estate · San Diego · Member since 2020 · 40 posts · 14 votes
    5y

    @Allen Scoging

    I am also on a similar page as you, trying to find a good duplex deal in SoCal. But I am trying to attempt it with very less down payment (3.5% FHA), and facing the same roadblock as you. The rents cover almost the PITI if I move out. When I occupy one unit, it does not reduce my current monthly rent I pay.

    The idea of going negative cash flow when budgeting for expenses for a long duration is sure scary for a first timer!. From what I modeled, I estimated that I can just break even(i.e. recover all my out-of-pocket expenses) only after 8-10 years if I sold the house. 

    0Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    5y
    Originally posted by @Allen Scoging:

    @Russell Brazil I'm basing it on $1.1MM purchase price and $5k gross rent from both units combined

     I dont know your tax rate, but thats showing slightly cash flow positive to me. 

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  • Allen Scoging
    OP
    Member since 2020 · 11 posts · 3 votes
    5y

    @Russell Brazil- That bring me a bit of comfort. My model doesn't account for tax benefits of owning a home, depreciation etc. I just know they exist and will make the picture a little better. 

    0Reply
  • Sean O'Dowd
    Specialist · Chicago · Member since 2021 · 45 posts · 22 votes
    5y

    I'll take a slightly different track. I'm the Chicago suburbs, but a downtown 3-flat (Chicago is weird and calls 3 units a 3flat instead of a triplex) in an A+ neighborhood like Lincoln Park or Wrigleyville will never cashflow

    My wife and I even looked at a couple that could be used as an owner-occupant and the rent from the other units don't offset the mortgage. They are very much "negative cashflow."

    However, these get snapped up in a second when they hit the market and there's a fairly large off-market network that sells them too. 

    The reason why is most investors aren't buying them for the cashflow. They're OK being negative a grand or two each month because they're building ~$2-5K a month of equity from the mortgage equity. 

    We have had a little baby, so we moved to the suburbs. In an alternate world where we didn't have the little guy, we would have bought one of these buildings as an owner occupant and been "negative" cashflow to build the equity

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  • Tim DelaneyPro Member
    Buffalo, NY · Member since 2018 · 790 posts · 530 votes
    5y

    @Allen Scoging it sounds like you are set on buying something and in my opinion taking the negative cash flow on a house hack would be better than buying a single family assuming two things: 1) the negative cash flow is less than you’re current rent and 2) you have a 6 month or more reserve to cover the full cost of the duplex if your tenant doesn’t pay. One other thing to consider is whether the duplex would cash flow if you rented out both units - even if it doesn’t today, will it by the time you are ready to move out? That would give you another exit strategy should you have to relocate for some reason.

    As for whether now is a good time to buy given that we may be at the top of the market - it is impossible to predict the markets. I am continuing to buy (when I can even find anything worth buying as an investment), but I’m in the Buffalo area where prices are quite different than the CA market. I know there is a saying about stock markets that I think also applies to real estate: “time in the market is better than trying to time the market”.

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  • Tucker Cummings
    Investor · Raleigh, NC · Member since 2019 · 433 posts · 743 votes
    5y

    If you're house hacking, don't over think this. 

    You're just trying to subsidize your mortgage. If you can get your tenant on the other side of the duplex to pay for at least 75-80% or more of your mortgage, you're doing just fine. Once you move out and rent out the other unit, you'll be plenty positive. 

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  • Allen Wu
    Rental Property Investor · Member since 2021 · 335 posts · 193 votes
    5y

    @Allen Scoging

    I’ll give you a similar scenario, but also want other BP folks to weigh in on my situation.

    I bought a condo back in 2015 for 300k. Now exact unit in my building sold for 500k. I’m up huge on equity, but cash flow on rental is like -300 with all in cost baked in (mortgage, taxes, HoA, insurance, accrual/cap ex). Should I keep it and keep putting in $300 or sell for a gain.

    Note: the reason why it’s -300 is because i had to refi for 20 years to get 1% off my mortgage rate. Initially, this property broke even every month, so if that’s the case for you, may worth considering.

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  • Zachary Beach
    Specialist · Los Angeles, CA · Member since 2018 · 291 posts · 231 votes
    5y

    @Allen Scoging I would look at the Cap rate(yes I know people jump over cap as it not how 4 or less units are sold but it's still a great evaluation number. If it's a 6 cap after putting aside for maintenance and capx and you can get a loan at 3% you make 3% on all the money you borrow if you put 5% down you make a 63% return on your down payment plus if so 3% appreciation you make an extra 60% so 123% first year return assuming you would have paid the same cost of rent as the market rent for the property anyway. The down side is that it will effect DTI and may make getting the next deal a bit harder but you have a great deal now.

    0Reply
  • Jonathan R McLaughlin
    Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes
    5y

    house hacking changes the usual equations. Your negative cash flow when living there is the cost of your rent. So, if you are down -200 a month, say, thats a pretty good rate for a rental apartment isn't it? And you have the principal paydown on the loan as part of the return as well.

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  • Scot Howat
    Investor · Hoffman Estates, IL · Member since 2014 · 434 posts · 185 votes
    5y

    Would you put $300, $500, or $1,000/m into a savings account?  If so, then why wouldn't you buy a negative cash flow property.  It's very similar, except that owning the assets will have tons of other benefits.

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  • Christina Labowicz
    Real Estate Consultant · San Diego, CA · Member since 2016 · 75 posts · 42 votes
    5y

    @Allen Scoging You mentioned you have 20% down, it sounds like you could use your 20% down to take to a suburb that would provide better cash flow and would not have to live there. 

    I am in the San Diego market and we run investment summaries to show what the total cash-on-cash return is before and after principal pay-down. Some investors here will leverage 95% financing just to put their name on the deal and collect the appreciation. If they take a hit on being out of pocket monthly it's because they ran the numbers and, as long as the out of pocket is going towards principal pay-down (which our cash flow sheet depicts) then they'll be ahead when they sell, they'll get everything they put towards principal back in the sale and will have taken advantage of tax savings and appreciation. 

    Of course, an ideal situation would be to cover all expenses and put some cash in your pocket each month, and there are certain suburbs that are more likely to do so (C class), but not all investors are willing to go to those areas especially when owner-occupying, so the latter is still a good option if living there and location is priority. Although, it sounds like a good situation for you if you have 20% down is to just buy a duplex in a C class suburb and continue renting. 

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