Cash flow negative but making a profit. I think?
Investor · New York City, NY · Member since 2017 · 13 posts · 2 votes
This is my first post so please be bear with me:
I own a co-op in NY and have been renting it out. The numbers: Mortgage – $1580 Maintenance - $1,462 Sublet Fee - $281 – so it costs me $3325 a month to keep the apartment. I rent it out for $3,150 a month Therefore, to justify the $175 a month loss – I figure as long as I cover Interest/ Maintenance/ sublet fee it works out. I think of the equity as moving money from my bank account to the apartment. (That I can eventually pull out) Yes, I understand that insurance and other miscellaneous items need to be considered, but I want to keep this simple.) The numbers I use so I do not loss sleep at night: Interest on the mortgage - $705 Maintenance - $1,462 Sublet Fee - $281 for a total cost of $2448 Therefore, I make a profit of $702 a month. Am I just deceiving myself?
@Antonio Palumbo I am in a similar situation. We paid retail for a condo where my daughter attends college. We rent two rooms which (depending on utilities each month) can go cash flow negative by about -$100 high end. But we are avoiding paying up to $30,000 in housing costs during her education. Potential small negative cash flow but we went in with our eyes open and if we get no appreciation or even a drop we still gained the value of NOT paying for her housing. We made the decision it was OK. When she graduates we will review and decide if worth keeping or selling and roll that to a different investment.
In another deal we were considering would have been a significant negative cash flow for 8-9 months to co-develop 2 single family homes with the potential of a nice pay-off. At that time we could not swing the negative cash flow and deemed could not take the risk.
With anything just make sure it is a deliberate decision and sounds like you have.
If you bought 10 of those you will be making $7020 a month by your math. You won't even need to work.
In all seriousness though, I have heard about people in areas with high appreciation and high property values doing what you are doing. I also remember distinctly that many people lost everything back during the recession when suddenly that appreciation that they were betting on didn't come through.
Thanks for the reply. I'm not betting on appreciation. It costs be roughly $175 out of pocket to keep an apartment in NYC. With the mortgage deductions, I break even but am building equity every year. Am I missing something? Maybe one day I can charge $175 more and have it be pure profit, but for now, I think it makes sense. What do you think?
All in the perspective. BP holds out 4 ways real estate is a benefit (going from memory so someone correct me if needed) .
So you know you are not receiving the benefit from the first item above and you should be able to determine if the others are working for you.
One key point @Anthony Gayden touched on is the risk. By NOT cash flowing you really increase your risk if there is a market shift. It is a very personal decision on how much risk to accept. Know your market and what you are betting on - sounds like appreciation. You might also set a target price that if it reached $X you would cash out and be happy with your return.
Good Luck!
@Ken Dillard I never heard it explained like that. It's definitely not cash flowing. Has it appreciated, Yes. The apartment is located in Manhattan. I've owned it for 8 years now, have been rented it out for 3. For $175 a month out of pocket, i dont think its much risk. But yes, if there's a vacancy, it will hurt.
Also, I have visions of giving it to my kids if they want to go to school in NY.
@Antonio Palumbo I am in a similar situation. We paid retail for a condo where my daughter attends college. We rent two rooms which (depending on utilities each month) can go cash flow negative by about -$100 high end. But we are avoiding paying up to $30,000 in housing costs during her education. Potential small negative cash flow but we went in with our eyes open and if we get no appreciation or even a drop we still gained the value of NOT paying for her housing. We made the decision it was OK. When she graduates we will review and decide if worth keeping or selling and roll that to a different investment.
In another deal we were considering would have been a significant negative cash flow for 8-9 months to co-develop 2 single family homes with the potential of a nice pay-off. At that time we could not swing the negative cash flow and deemed could not take the risk.
With anything just make sure it is a deliberate decision and sounds like you have.
@Antonio Palumbo, your mortgage is (only) $1,580/m? Just how cheap was this Manhattan co-op? (Or perhaps more tellingly, how much of your own CASH did you put down at the start, generating ZERO return until you cash out again?)
[By the way, for your sleep's sake, it's the PRINCIPAL being paid down per month that might help, not the interest].
Welcome to BP. All the best...
Hi @Brent Coombs. Interesting way to look at it (own CASH did you put down at the start, generating ZERO return until you cash out again?)
20% down since it was my primary residence.
Am i mistaken in thinking that principal is me just moving money from my bank to the apartment?
Again - the rent covers, my maintance, mortgage interest, and sublet fee. I'm more then happy to pay principal which increase equity and my networth.
Thank you for the welcome
You definitely have an investment that is increasing your net worth. You could look at it more as putting $175 into a retirement account, except you're coming out much better than that... You get:
@Antonio Palumbo My personal opinion, you're deceiving yourself when it comes to saying you're "making a profit for $702 a month". This could still be an awesome purchase for you for someone of the reasons you've listed. So why aren't you making $702 a month? Personal opinions follow...
Yes, you're building equity but what if you have to sell? It's 6% commission to realtors, some money to get it "sale ready", carrying costs during the time it's listed and in escrow, depreciation recapture, and capital gains on any profits. By the time you look at maybe 10% total costs to sell, capital gains of 15%, depreciation recapture, it's a good chunk of that hypothetical profit. I'm not saying that it will wipe out all of that $702 a month but it will wipe out a lot of it if you sell in the near term and a chunk of it when you eventually sell. A profit is only a profit when you capture it. In real estate when appreciation is your profit there are weighty costs associated with capturing that profit. It ain't free...
Others have also pointed out the obvious, there's no guarantee that properties will keep appreciating. Life looks awesome if you bought in 2008. Life looks very mediocre if you bought in 2006. And I'm going to make an educated guess that if you bought in 2006 at "losing $175 a month" you lost a lot more when rents dropped. So those people that just had bad luck on timing (plenty of smart people bought in 2006, careful of hindsight making someone a genius) paid a lot out of pocket, for years, and it wouldn't surprise me if they are just getting back to break-even now.
All of that negativity aside, you bought it with a plan. You're happy to come out of pocket $175. You have visions of letting your kids use it in the future. There are a ton of reasons why this could be a great deal for you. Odds are that NYC will appreciate over the long term. Odds are you'll end up in a great place when you stretch out the timeline. But...you're still not making a profit of $702 a month.
Hope that helps...doesn't sound too negative...it probably reads like I'm a grumpy ol' naysayer...
@Austin Fruechting Exactly what I was thinking. and eventually the mortgage will go away and I'll have the added benefit of positive cash flowing. The apartment is already 65% paid off
I bought in 2009... When most people wouldn't touch real estate in NY. (I like to think I was lucky?) Can you tell I'm new to this? Was I lucky?
Thank you for your opinion, believe me, I struggle with this all the time. All i know is that i probably cant rebuy in Manhattan at today's prices. Great point about reselling. It's definitely not free
@Austin Fruechting Exactly what I was thinking. and eventually the mortgage will go away and I'll have the added benefit of positive cash flowing. The apartment is already 65% paid off
Yeah, you aren't making a "profit" in the traditional sense, but if you re-paint the scenario as "what would that $175 a month do if you put it in an retirement account" you are certainly coming out better on the balance sheet. There's a lot of equity there you could put to use in other investments if you sold it. And you could definitely beat the returns elsewhere in REI, but compared to an investment account you're killing it on the $175 a month investment. The question to answer for yourself is how does it all play into your overall goal and plans.
@Antonio Palumbo You'll know you're lucky when you sell! Or refinance to pull money out and still only "lose" $175 per month because rents have increased. By the way, there are plenty of people in a similar situation to yours where they can invest in a duplex that (because they occupy one side) might "lose $1,000 per month" but they're saving $2,000 per month on rent. So in some cases I could easily argue that a cash-loss isn't really a cash-loss. That's why, at the end of the day, it all boils down to whatever your plan and investment thesis are. Some people will invest in Detroit thinking a turnaround is underway, others invest in the Bay Area because tech growth will never stop, others will invest in NYC because it's, well, NYC. And someone will have a thesis as to why Albuquerque is the best option. There's nothing materially wrong with any of these ideas. Time will tell who is right and who is wrong. Or maybe just who is right and who is "more right".
What is material is that any investment decisions that are made are stress-tested. If you can afford to lose $175/month for the equity gain but can't afford to lose $300/month you have to assess if you think rents might drop. If someone has a great W2 they can afford to take a little more risk on cash-flow going from break-even to negative or slightly negative to more negative. If someone, however, doesn't have reserves (seldom talked about) or alternative income sources and the maximum they can afford to lose before starting to have mortgage-lates in $175/month, that's a different story.
@Patrick Senas yes to raising rent. I have done 2 year leases. So i raised it 5%. Lease is up in 2018. I will reassess rents again and see what I can get away with.
@Andrew Johnson Great point. Yes - Reserves are key. I guess that's why I dont consider $175 as losing money in the traditional sense. I look at it as, like @Austin Fruechting said; I'm putting $175 a month (might go away if i raise the rent again) towards owning an apartment in NYC. I already have 65% equity in it. So once i pay it off, it will generate money for me without all the "funny math"
I guess I was looking for some reassurance from some seasoned vets.
You are defiantly deceiving yourself. You have major negative cash flow if the place is 65% paid off. If you under stood the value of dead equity and the true purpose of investing you would not be sleeping at night. Ignorance is bliss.
Heaven for bid if the day ever comes when the impossible occurs, the market turns and good buy equity.
@Thomas S. How am I ignorant? I'm looking for advice and it seems like most folks are on the fence. The apartment has easily appreciated and I'm not even taken that into account in my analyses. @Cody L. - maybe savings is not the best word. I wonder how much you pay for mortgage interest a month?
"How am I ignorant?"
Cash or equity has a opportunity value of 10% minimum to investors. For every 100K in equity you are reducing your cash flow by $866/month.
Paying down a mortgage reduces cash flow on a property it does not increase it as "ignorant" investors tend to believe.
If a mortgage is at 4% and cash has a opportunity value of 10% every dollar of equity is costing (or losing) a investor 6%. In essence you are buying artificial cash flow at a very high dollar cost.
Ignorant investors place a value of zero on dead equity. Being conservative investors is fine but the reality is that many actually never make any true profits when all costs are taken into consideration.
If a investor ever tells you he is paying down his mortgage to increase cash flow , don't walk...run away as fast as you can.
@Antonio Palumbo , welcome.
Many investors on this BP forum are mostly interested in an investment property that cash flows. I'd encourage you to read up on the BRRRR method, as one way to grow wealth the quickest, and it works best if you use high leverage, (i.e. you have minimum equity in the property and maximum loan size).
Read on these forums the targeted "2% Rule", wherein you buy a rental property that has rent per month equal to 2% of the purchase price. (if your $3,150 per month place in NYC could be purchased for $157,500 , then you'd be in the best zone for cash flow. I'm guessing NYC isn't a 2% City....yes, many of them are in the Midwest with a $50,000 home bringing rent of $1000/mo) Note that this rule is independent on how you finance the purchase, or how much down payment you put into it.
Then, investors try to finance the property such that with 20% down payment, 80% loan, and considering other insurance, taxes, maintenance, capital improvement, they get net cash flow of +$300, per month per property. They then calculate their return on capital as the $300 per month ($3600 per year), divided by a $20,000 down payment (ie. 20% down on a $100,000 unit) and calculate that they are making 18% APR on their cash employed. Note that the 18% cash on cash yield is possible with 20% down payment, in this case. A person paying 100% equity and no loan, will calculate a higher net cash flow per month (without a mortgage payment) but will have a dramatically lower cash on cash yield.
Note that this "cash on cash return" is just the cash flow compared to the cash invested, and ignores the principal repayment by the tenant, and ignores any market appreciation (if any).
You are getting comments above because you have a -$175 per month cash flow, and therefore, your "cash on cash return" is negative. You are hopeful that you still have a viable "investment" because you like the tenant paying down your principal monthly (growing your equity, but not cash in your checking account). (@Cody L. is correctly making this distinction, and clearly strives to have the monthly cash flow.....his equity growing by $50,000 per month is not to be ignored however...... but he'd have to sell a property and/or cash-out refinance a property to convert that unrealized gain into spendable cash, and may have a taxable capital gain to pay tax on, too).
You haven't stated, but you might have $300,000 or $500,000 tied up in your down payment and growing equity over the past 8 years. Others are questioning why you would be happy with no cash return on that investment. You could instead have it invested in indexed mutual funds and get perhaps 8% yield, without all the risks and headaches of real estate investment. Folks like @Thomas S. are correctly pointing out that the "opportunity cost" of having so much of your capital tied up in your down payment is only effectively earning you about 4% yield (if your mortgage is 4% APR)....and why not extract it and put it to work in a property yielding 15% or 18% annually.
So, if you have $500,000 equity in the property and are happy that you're getting $700 per month in principal repayment, that's only a 1.7% annual yield.....you'd be better in a different investment.
I looked at a housing index for NYC....looks like it's up about 10% in last 8 years.....1.25% appreciation per year. So, you might be getting 1.7% from principal repayment and 1.25% from appreciation....are you thus netting just 3% annually on your risky investment?
Good Luck.
Hi @Brent Coombs. Interesting way to look at it (own CASH did you put down at the start, generating ZERO return until you cash out again?)
20% down since it was my primary residence.
Am i mistaken in thinking that principal is me just moving money from my bank to the apartment?
Again - the rent covers, my maintance, mortgage interest, and sublet fee. I'm more then happy to pay principal which increase equity and my networth.
Thank you for the welcome
I guess you CAN say "principal is me just moving money from my bank to the apartment", but it's perhaps more correct to say: "principal is the money paid from my bank (or my Tenants) - that lowers my amount owed"!
ie. Paying the INTEREST portion of your mortgage does NOT decrease your amount owed.
How come you've paid an extra 56.25% PRINCIPAL off your original loan, in just 9 years? (ie. 45% additional paid off equity = 56.25% off the original 80% LTV Loan). Have you been paying extra, even though you weren't required to? (And if so, did you wisely do that as "principal-only" extra payments?)
ie. A "normal" amortized 30 year loan would have paid off less than 25% of the loan over the last 9 years.
I'm also curious about why you moved out? Is your new primary ALSO a purchase? How does THAT one rate, vs renting?
One more question: Does the $1,462 monthly Maintenance fee cover EVERY capital cost that you might face? Cheers...
Good morning BP - well... I lost sleep last night. THANKS. @Steve K. thank you for the thorough reply. I have about 300k in equity in my apartment; but you're right that 300K is not doing anything for me in terms of cash flow.
@Brent Coombs - Yes - i have aggressively been paying the mortgage down. I'm old school, and hated the idea of paying interest to the bank. yes - all extra payments went towards principal.
Why did i move out? - As you guys can probably tell; I'm not into real estate. This was my first home. I lived there for about 5 years. I was fortunate enough to save up another 20%, buy a home and moved to the suburbs with my family. So rather then sell my apartment, i gave renting it out a shot. Not so much as an investment, but more to keep an asset that was almost paying for itself.
knock on wood - i haven't had to do anything maintenance wise for the tenants. I did a renovation when i purchased it that cost 30k - So all and all, the apartment cost 500k. 9 years later - its probably worth 600 - 650k.
@Douglas Krofcheck - Luckily the apartment is in Manhattan and I feel confidant the values will hold.
Emergency fund - Yes, i have it. i have a diversified portfolio with cash savings, 401k's, brokerage accounts. etc. So i have breathing room.
So yesterday was the first time I heard about BRRRR. and I guess I have been doing it wrong!
What BP has taught me in 24 hours is that i need to rethink Real Estate if i want to make real money with it. I went from wanting to pay down an asset. to wanted to maximum my cash and put it to work. It doesn't make sense to have all that cash tied up doing nothing. (see guys, I'm learning) I definitely want to do a few BRRRR deals.
Any advice guys - should i sell my place? or pull the money out via HELOC?
Hello to day 2 on BP
you said "
So yesterday was the first time I heard about BRRRR. and I guess I have been doing it wrong! "
....not necessarily. For buy and hold rentals, there is a continuum of perspectives. I know of one widow in Denver who put her life savings into a $225k rental duplex...paid cash, no loan/leverage. Has just one property and is thrilled that it cash flows and there is no mortgage payment. Thrilled that it has doubled in value in 7-8 years (Denver appreciation has been great) and she's averse to debt. She is truly a real estate investor....but on the conservative (not comfortable with debt) end of the continuum.
Others could have taken that same precious capital and invested it in 4 similar properties, with 25% down payments and 75% loans/leverage, and controlled $900k in property that doubled to $1.8M by now. They'd be wealthier, because they used 75% leverage. Admittedly, if a nationwide recession hit, and property values and/or rent dipped 15 or 20%, this person is subject to loosing 15-20% of $900k in properties, rather than the widow's 20% of $225k.
Then, if you use the BRRRRR method, the cash-out refinancing, once you have enough equity (usually through remodeling the property, but sometimes through market appreciation) allows you to ideally grow a portfolio of rentals with 100% financing....and zero of your precious equity left in the property.....I know of a BRRRR investor that turned $80k cash into 30 rental properties worth about $8million ($5million in loans, $3million in his equity) in 5 years....granted, he bought at the bottom of the 2006-08 recession and benefited....but much of it was the buy at a discount and remodel profit.
Read some real life case histories of BRRRR success here on BP:
I think , and did in 5, 2.5 years and 7 years, respectively, buy using BRRRR:
https://www.biggerpockets.com/forums/223/topics/459415-500k-net-worth-in-5-years-im-30-today?page=1
As to your NYC rental, if it appraises for $650k, and you took a 75% loan, you'd have $162k of your own money tied up in it, but about $150k of that is your appreciation since you owned it. You'd be investing for appreciation, not cash flow (search BP for that topic; it's often debated here).
Or, if you choose to trade for another property(ies) with that equity, read about 1031 exchange. You can sell your NYC co-op apartment and reinvest (1031 exchange) in other properties, and defer the capital gains tax on the $150k of gain you have.
Good luck.