Advice appreciated! - Negative cashflow but positive equity?

OP

Rental Property Investor · Fort Collins, CO · Member since 2017 · 41 posts · 10 votes

9y

> My question is why would you go into a deal knowing that you will lose money every month?

@Scott Trench Thanks for the reply! Yes, that is basically my question. The only possible reason I can see is: that the renter is buying the house for you. So the cash flow lost each month would have to be weighed against the equity gained. Let's assume for argument's sake that there is an equity gain of $800/month, then subtracting the negative cash flow of $-310.25 still leaves a positive $489.75 every month ($5877 per year).

Do investors simply not include the equity gains when calculating ROI?

Thomas S.

Member since 2016 · 13k+ posts · 12k+ votes

9y

Are you planning on expanding your investments in the future. How many negative cash flow properties do you expect to be able to support while growing.

Obviously what you are suggesting is highly risky and not a move that I would ever consider to be investing. You may be farther ahead buying lottery tickets.

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Alexander FelicePro Member

Guy with Great Hair · Austin, TX · Member since 2013 · 2k+ posts · 4k+ votes

9y

Every investor has their tenant pay off the mortgage, hopes for appreciation, and wants to make positive monthly cash flow.

....and you can do all 3, but not on this house. So you're gonna HARD PASS on it.

goal is to make money, this doesn't make money. Move on to something else, quickly.

2 Reply

Andrew Johnson

Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes

9y

Daniel Walker From where I'm sitting I can't help but ask: is this (for whatever reason) the only deal that's an option for you? If you had a property that was break-even or cash-flow positive wouldn't you still get the benefit of the equity build? I mean, maybe I could try and rationalize this if you had a W2 of $500K and were happy to lose money now for equity building because of marginal tax rates. But even in that scenario you'd still get some tax-free income due to depreciation, mortgage interest, etc. so you likely wouldn't want to aim to lose money. The net result is that I can't grasp why you'd want to THIS deal. Are the other deals that much worse? I just have to believe I'm missing something.

2 Reply

OP

Rental Property Investor · Fort Collins, CO · Member since 2017 · 41 posts · 10 votes

9y

@Thomas S. yes I do want to expand in the future. My question above is partly to play devil's advocate, to see what sort of feedback I get from the general community. My main problem seems to be: finding a good deal which requires low maintenance in terms of time and money. I am still curious as to people's responses to the "straw man" I quoted above.

Thomas S.

Member since 2016 · 13k+ posts · 12k+ votes

9y

OK then in response to your "devils advocate" as a hypothetical ... any person that would buy under that scenario is never going to be a investor because they are simply too stupid to ever understand finances.

OP

Rental Property Investor · Fort Collins, CO · Member since 2017 · 41 posts · 10 votes

9y

Thanks for the immediate reactions folks! Looks like my post is generating feelings of repulsion! :) This feedback is mirroring my initial reaction when I put these numbers together. I have a retail RE agent with whom I have purchased the last two houses I lived in. Though she knows I am buying to invest I am thinking I might need to transition to a more investment-minded RE agent.

@Andrew Johnson I do have a decent W2, but nowhere near that decent! The market where I am is very tight but I am only now exploring ways of looking beneath the surface in terms of finding opportunities. Thank you for taking the time to share your reaction.

OP

Rental Property Investor · Fort Collins, CO · Member since 2017 · 41 posts · 10 votes

9y

> OK then in response to your "devils advocate" as a hypothetical ... any person that would buy under that scenario is never going to be a investor because they are simply too stupid to ever understand finances.

@Thomas S. Telling it how it is! Thanks for the candor! :)

David Zheng

Investor · Saint Louis, MO · Member since 2016 · 970 posts · 1k+ votes

9y

@Account Closed What happens when the market crashes or there is a correction. That "equity" becomes nothing. its just dead imaginary money in the property that you "hope" will turn out high if you end up appraising/selling it.

OP

Rental Property Investor · Fort Collins, CO · Member since 2017 · 41 posts · 10 votes

9y

Originally posted by @David Zheng:

@Account Closed What happens when the market crashes or there is a correction. That "equity" becomes nothing. its just dead imaginary money in the property that you "hope" will turn out high if you end up appraising/selling it.

I have had others give me advice that the equity would make this worthwhile. And historically our area is one of the most resistant to negative price fluctuations. However your point still stands. I am feeling out what I should be looking for / willing to accept, by gauging the reactions of people. They do say that there are no stupid questions! Thanks for your comment.

David Dachtera

Rental Property Investor · Rockford, IL · Member since 2014 · 4k+ posts · 2k+ votes

9y

@Account Closed,

Yeah - like the others have said: not good.

That $1095 ... is that consistent with area rents, or can you raise it at least $400/mo? That brings you positive, at least a little. Better have some reserves of your own, though. $90/mo won't build up very fast.

Trouble with a lot of town homes is the HOA. That's pretty steep by my standards, but might be common out your way. The HOA better be doing a LOT for THAT money!

Either way, unless the tax benefits from the write-offs will balance the negative cash flow, not a good deal. Move on.

OP

Rental Property Investor · Fort Collins, CO · Member since 2017 · 41 posts · 10 votes

9y

Originally posted by @David Dachtera:

@Account Closed,

Yeah - like the others have said: not good.

That $1095 ... is that consistent with area rents, or can you raise it at least $400/mo? That brings you positive, at least a little. Better have some reserves of your own, though. $90/mo won't build up very fast.

Trouble with a lot of town homes is the HOA. That's pretty steep by my standards, but might be common out your way. The HOA better be doing a LOT for THAT money!

Either way, unless the tax benefits from the write-offs will balance the negative cash flow, not a good deal. Move on.

I have explored the rent numbers that would be necessary to make this work. Unfortunately they're higher that what would likely be supported. The number of $1095 is based on the rate at other townhouses in the same building, and also based on advice from the property management company I used for our other house (which generates a few hundred positive each month). The HOA is a lot, but that number is fairly common here in Fort Collins, CO. Thank you for your advice!

Tenzin GyaltsenPro Member

Real Estate Agent · Denver, CO · Member since 2017 · 21 posts · 8 votes

9y

Hey Daniel, I saw you're thread for the investment property and I 100% agree that you should find an agent that thinks like an investor. Most agents just help people buy and sell houses with little to no thought on house to generate cashflow. It's not impossible to find cashflowing properties here in Colorado but it isn't easy either. The values are so high it's hard to generate positive cashflow. In my opinion, I'd seek properties in other states with more linear markets. You won't have the crazy appreciation like you might here but you can purchase a property that will generate money. Check out this podcast (http://www.noradarealestate.com/) and listen from episode 1. They do try to sell you on turn key properties but the information he dishes out is invaluable. I highly recommend giving it a listen. You can use his strategies to invest in remotely. Cheers,

OP

Rental Property Investor · Fort Collins, CO · Member since 2017 · 41 posts · 10 votes

9y

Originally posted by @Tenzin Gyaltsen:

Hey Daniel, I saw you're thread for the investment property and I 100% agree that you should find an agent that thinks like an investor. Most agents just help people buy and sell houses with little to no thought on house to generate cashflow. It's not impossible to find cashflowing properties here in Colorado but it isn't easy either. The values are so high it's hard to generate positive cashflow. In my opinion, I'd seek properties in other states with more linear markets. You won't have the crazy appreciation like you might here but you can purchase a property that will generate money. Check out this podcast (http://www.noradarealestate.com/) and listen from episode 1. They do try to sell you on turn key properties but the information he dishes out is invaluable. I highly recommend giving it a listen. You can use his strategies to invest in remotely. Cheers,

Thanks for the advice! Yes, it seems every single town home I look at results in upside down numbers. I have given a little thought to out-of-state, and will be spending more time thinking about that and discussing options with people at local meetups. Thanks for the podcast recommendation. I will definitely check it out!

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

9y

Originally posted by @Account Closed:

> My question is why would you go into a deal knowing that you will lose money every month?

@Scott Trench Thanks for the reply! Yes, that is basically my question. The only possible reason I can see is: that the renter is buying the house for you. So the cash flow lost each month would have to be weighed against the equity gained. Let's assume for argument's sake that there is an equity gain of $800/month, then subtracting the negative cash flow of $-310.25 still leaves a positive $489.75 every month ($5877 per year).

Do investors simply not include the equity gains when calculating ROI?

You have just fallen victim to the Investor's Most expensive word..."rationalization".

First, the tenant isn't buying the house for you if you have negative cash flow...you are...and, you're paying your tenant to live in your house at the same time.

What are (were) your plans for the cash coming out of your pocket to cover that negative cash flow...that is if you didn't have to give it to your tenant to cover their "under payment"? See, that negative cash flow money you are spending (and losing), probably had a different use in mind. Now if you still have to have cash to use for that "other" use of those funds, you have to use alternative cash for that too. That means your actual cost here is 2 times that negative cash flow. Once, for the tenant, and the 2nd time to cover your expenses that those "tenant" funds were supposed to be covering.

Now the big one...no that wasn't it. What are you going to do with all that equity you are building up? It's pretty useless until you tap into it...and you can't tap into it by refinancing, or you get more negative cash flow. By the way, ask anyone banking on equity how they did in 2008. Also, where did you come up with $800/month in gained equity? I hope it doesn't include your contributions to it. That's not equity. All you are doing is putting money under a mattress in the rental house. That "equity" represents your cash...not profit, so you can't count it. Now, if your tenant was paying for it, (i.e.Positive cash flow...), that would be different....and would be profit.

There's more...not good. What are your plans for your next property? How are you going to pay for it? How many more of these "gems" can you handle?

7 Reply

Shawn L.

Rental Property Investor · Natick, MA · Member since 2015 · 128 posts · 188 votes

9y

Originally posted by @Account Closed:

> My question is why would you go into a deal knowing that you will lose money every month?

@Scott Trench Thanks for the reply! Yes, that is basically my question. The only possible reason I can see is: that the renter is buying the house for you. So the cash flow lost each month would have to be weighed against the equity gained. Let's assume for argument's sake that there is an equity gain of $800/month, then subtracting the negative cash flow of $-310.25 still leaves a positive $489.75 every month ($5877 per year).

Do investors simply not include the equity gains when calculating ROI?

I'd take a look at an amortization schedule to see how little of your payment goes towards principle for the first 1/3 to 1/2 of the term of your loan. This will probably change your thought process.

2 Reply

OP

Rental Property Investor · Fort Collins, CO · Member since 2017 · 41 posts · 10 votes

9y

@Joe Villeneuve thank you for this excellent post! This is just the sort of fire I was hoping to see my feet held to.

Though we have sufficient W2 income to cover the negative cashflow I recognize your point about the opportunity cost of having these funds sunk into this.

Also, the lack of ability to refinance (since it would return to or exacerbate a negative equity) is obvious but had not occurred to me. The "exit" is something I'll be more mindful of when looking around.

The $800 is a made-up figure to allow me to ask this question. It's based on a mortgage calculator principal and interest value. I recognize (and knew at the time of posting) that this does not represent the true picture of equity. Again, to get valuable responses like yours I think it was worthwhile throwing the numbers out there.

> All you are doing is putting money under a mattress in the rental house.

This is a great way of describing what would be happening.

> That "equity" represents your cash...not profit, so you can't count it.

Also I had not though of it this way.

> What are your plans for your next property? How are you going to pay for it?

At this exploratory stage, it was a handwavy "I'll save up the money". We do have quite a bit of spare income. However I am beginning to explore how I can grow my investment without (fully) relying on our W2 salary to fund it.

Thank you for taking the time to articulate these thoughts!

Daniel

OP

Rental Property Investor · Fort Collins, CO · Member since 2017 · 41 posts · 10 votes

9y

@Joe Villeneuve

> You have just fallen victim to the Investor's Most expensive word..."rationalization".

This is it in a nutshell! I'm looking forward to sharing some of this feedback with my current agent.

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

9y

I deal with thi same tought process all the time at my REIC. Most of it stems from the way we are taught (or not taught) about how money works. Money isactually a verb, not a noun. When it becomes a noun...you lose.

Stephanie Dupuis

Residential Real Estate Broker · Bremerton, WA · Member since 2013 · 494 posts · 142 votes

9y

Hard Pass. If it doesn't CF, it's a bad purchase. And...it's a purchase, not an investment.

3 Reply

Logan McConnell

Fort Collins, CO · Member since 2015 · 39 posts · 6 votes

9y

stay away!

Townhomes don't appreciate like single families and with the negative cash flow, no thank you. Have you looked into single famly properties? A 3 bed which allows a dog within 3 miles of old town will rent for $1500 min these days. And I have seen plenty listed for under $300k. Adding the dog can offen allow you to add 10-20% to the average rent in the area. People are dog crazy in this town. Plus, some dog owners are better tanants than some of the lazy slobs out there, you just need to feel em out and call references.

OP

Rental Property Investor · Fort Collins, CO · Member since 2017 · 41 posts · 10 votes

9y

@Logan McConnell, yes we currently own a 3br pet friendly SFH in Brown Farm (w. Drake) which brings in $1600/m and we were lucky enough to have bought in 2011 so it cash flows nicely.

The thinking behind looking at townhomes was to reduce the maintenance costs, however finding something where the numbers make sense is proving to be very difficult. Perhaps this is a signal to expand the search to include SFH again. I know what you mean about the dog crazy nature of this town. It's one of the many reasons I love it!

Mike Roy

Rental Property Investor · Bath, ME · Member since 2014 · 220 posts · 288 votes

9y

We saw a lot of this kind of rationalization in 2006/2007. Those properties eventually went negative cash flow AND negative equity.

If you're not cash flowing, you're speculating. At this point in the cycle, I'd rather have that $55k in the bank. Better deals are coming!

Justin B.

Investor · Gaithersburg, MD · Member since 2013 · 659 posts · 441 votes

9y

It's just my opinion but while equity can be a powerful thing, if it negatively cash flows I would never do it. It's too easy to find deals with cash flow and equity.