Is operating with negative cash flow a good move?

28 Replies

Hello, this post is an update to my previous post : 

To summarize that post: buying a house for ~$250k w/ a 30-yr fixed rate loan, will try to lease it out for ~$2k a month, monthly expenses are ~2.2k a month.

The fixed rate loan is for 30 years, 4.75% and 3.5% down. I used https://www.bankrate.com/calculators/mortgages/amortization-calculator.aspx to calculate how much equity I would be getting at 5, 10, and 20 years. These numbers are:

11.9% equity in 5 years (.119*250k =$29750)

21.8% equity in 10 years ($54500)

52.0% equity in 20 years ($130000)

100% equity in 30 years ($250000)

The numbers above are considering that the house stays at 250k in 30 years, but I think it will appreciate [Pflugerville / Round Rock, TX] (need to do more research)

Is this a possible equity play? Or am I better off trying other investment vehicles? Thanks.

I wouldn't do it. I started investing in 1983 in NYC ad went through two market peaks, and I believe the next one is coming.

At market peaks, RE values and rent tend to go through a correction, sometimes major. My first investment was a triplex which I bought in 1983. The market peaked here in 1986, and some investor bought the triplex next to mine in 1986, the peak, negative cash flowed, couldn't hold on, sold it for a $50K lost to a 2nd investor in 1990, and the 2nd investor sold it for a lost in 1993 of another $50K as well, because he also negative cash flowed.

For my triplex, I lived in one unit, the other two units carry the mortgage, so I survived the downturn OK, but sold it after the market picked up, at 3 times what I paid for it. 

Negative cash flow will kill you at market tops.

Originally posted by @Frank Chin :

I wouldn't do it. I started investing in 1983 in NYC ad went through two market peaks, and I believe the next one is coming.

At market peaks, RE values and rent tend to go through a correction, sometimes major. My first investment was a triplex which I bought in 1983. The market peaked here in 1986, and some investor bought the triplex next to mine in 1986, the peak, negative cash flowed, couldn't hold on, sold it for a $50K lost to a 2nd investor in 1990, and the 2nd investor sold it for a lost in 1993 of another $50K as well, because he also negative cash flowed.

For my triplex, I lived in one unit, the other two units carry the mortgage, so I survived the downturn OK, but sold it after the market picked up, at 3 times what I paid for it. 

Negative cash flow will kill you at market tops.

Thank you for your input. Is there a way for me to get more information on how the market will be like for my area?

Probably your best bet would be to see how values and rents acted at the last correction is 2008-2009

that is an owner occ loan..   not germane to a rental scenario.  nega tive cash flow is OK if your in a market that you have some degree of faith will continue to rise substantially in value.

I’m no big shot investor but I don’t see the point in doing that .i guess maybe I’m missing something others see . Your doing this to make money not just to accumulate property and hope for appreciation which is not even a sure thing . It takes time effort and work . Sure it could appreciate in value and pan out to be a great deal down the road someday , but it might not and then you could really be in a pickle and with no cash flow and your capital time and effort are in vain . Many people lost millions in the housing bubble betting on appreciation . If you have the wherewithal Why not buy properties that cash flow AND appreciate .

An investment property requires a minimum of 15% down. If you are putting 3.5% then that is an owner occupant loan. 

Negative cash flow should only be acceptable when there is another aspect such as flipping or a value add play and generally not for the long term unless you are trying to offset other passive gains. 

Also, as others have said, the 3.5 is not feasible but if you find a lender that will do it please let me know. lol

Originally posted by @Russell Brazil :

An investment property requires a minimum of 15% down. If you are putting 3.5% then that is an owner occupant loan. 

I'm going to live there for the first 2 years, and be able to lease it out to 2 friends while I'm living there for ~1k each. Then I want the ability to leave and continue leasing it out. Does this change anything?

Originally posted by @Peter M. :

Negative cash flow should only be acceptable when there is another aspect such as flipping or a value add play and generally not for the long term unless you are trying to offset other passive gains. 

Also, as others have said, the 3.5 is not feasible but if you find a lender that will do it please let me know. lol

I'm going to live there for the first 2 years, and be able to lease it out to 2 friends while I'm living there for ~1k each. Then I want the ability to leave and continue leasing it out. Does this change anything?

Originally posted by @Kelvin He :
Originally posted by @Russell Brazil:

An investment property requires a minimum of 15% down. If you are putting 3.5% then that is an owner occupant loan. 

I'm going to live there for the first 2 years, and be able to lease it out to 2 friends while I'm living there for ~1k each. Then I want the ability to leave and continue leasing it out. Does this change anything?

 Yes. You should not expect cash flow with a minimal down payment. 

Originally posted by @Russell Brazil :
Originally posted by @Kelvin He:
Originally posted by @Russell Brazil:

An investment property requires a minimum of 15% down. If you are putting 3.5% then that is an owner occupant loan. 

I'm going to live there for the first 2 years, and be able to lease it out to 2 friends while I'm living there for ~1k each. Then I want the ability to leave and continue leasing it out. Does this change anything?

 Yes. You should not expect cash flow with a minimal down payment. 

 Would you go ahead and purchase a house then, knowing the equity I'm gaining should outweigh the negative cash flow?

@Kelvin He

@Dennis M.

Dennis, I want to point out that Kelvin indicated that he is NOT BETTING on Appreciation.

What Kelvin is doing is betting that his 96.5% LTV loan of $240k of a $250k purchase will disappear in 30 years, which it will. That's just Math.

Additionally, he will take a $200 per month loss in the 1st year he rents it out entirely ($2,200 expenses but only approximately $2k in rents).

Let's just assume the above scenarios plays out for the entire 30 year holding period.

So Kelvin will lose $200 per month or $200 x 360 months = $72,000.

Assuming NO APPRECIATION, the mortgage disappears in 30 years.

If Kelvin then sells the property at the same price of $250k, his return would be $250k minus $72k minus $10k for down payment = $168k profit in 30 years.

Considering that Kelvin would only put in $10k as a down payment, $72k as payments towards the property over the 30 years, his investment is $82k which then returns proceeds of $250k.

If we did a non-compounding calculation of ROI we get $168k profit / $82k Invested = 204% in 30 years or 6.8% per year.

If we did a Compounded Rate of return, we get a 6.12% IRR over the 30 years. Here is the IRR Chart:

What Kelvin is saying is that this is the most pessemistic scenario where he will have ZERO Appreciation AND NO CASH FLOW INCREASES due to increasing rents versus expenses.

Kelvin can then come up with an optimistic senario, such as add 5% annual appreciation with 2% annual cash flow growth.

That would supercharge his IRR.

Aside from this, the danger, as others state, is that Kelvin cannot afford the negative 200 per month cash flow. BUT.... common guys... negative 200 per month?! I mean this doesn't kill anyone that I personally know who has disposable income to buy an investment, even for $10k savings like Kelvin.

Of course there are a ton of other considerations such as Capital Expenditures and Tax Savings, but we are not building a very complex and sophisticated spreadsheet just yet. If it were me, I would actually do it.

I would definitely look into the economic factors that are going to be driving the value of the properties in that area as well over the 30 years, however.

To me you can get the numbers completely correct, but if you don't know the economic trends that are happening, a good investment can turn into a nightmare no matter how much cash flow you are generating over the years.

There are too many examples of cash flowing properties that stopped cash flowing such as places like Detroit, Bethlehem, Allentown, etc. Generally one industry towns where the Industry dried up.

The economics is a necessity to long term buy and hold investing. If you are not doing that, good numbers can turn out bad.

But that being said, this is well within my risk tolerance level as long as there are no negative economics that will impact the next 30 years.

Only do this if you are using the property as a tax deduction on your other income. Ideally if you qualify as a real estate professional for tax purposes you can use a breaking even or negative cash flow property and depreciation to pay no taxes on the property and to offset other income.

I wouldn’t suggest this because why not by a property that cash flows instead. Some people will say that there are no properties they can find that cash flow. If that is the case use master leasing to cash flow

My feeling about this is if you don’t know if this is a good idea then it’s a bad idea.

People who this works for know *their* numbers, how it fits into *their* portfolio, and has an understanding of the risks and the returns.

I can probably get 2K? Man I’d know my stuff before I even thought about a deal that. I always get a queasy feeling when I see this question. I worry when I see people convince themselves that a lousy deal is pretty good.

Llewelyn did a good job of showing the basic math as long as nothing ever goes wrong. And it also ignores the time value of money and opportunity cost.

Is it doable with appreciation and improved rents? Absolutely. A lot of people got wealthy this way... oh and a lot of people have gone broke and realized “real estate doesn’t work” when they try it too.

@Llewelyn A. did a great job showing the numbers.  Great post as usual.   So I will take a different approach.  

RE Is very localized.  Certain locales are about cash flow, other locales are more appreciation plays.  

In my market a rent to total cost ratio of 0.75% is very good. At 0.75% I can show positive cash flow at non-owner LTV. The OP property is at 0.8%. If it did not have any obvious landlord issues or other issues I would purchase it. The negative cash flow is based on 2 things: 1) the very low down payment (3.5%) 2) OP is actually occupying the property. If OP cash flow projections are correct, OP is living at the property for a $200/month cost basis (the negative cash flow). I do not know many people living somewhere for a $200/month basis.

If OP put 20% like most RE investors, OP would certainly have positive cash flow.  In addition, if OP was not occupying the unit they would have positive cash flow.  

In my market I would purchase this in the blink of an eye and be quite happy. The equity pay down would be gravy. I would expect rent appreciation to overcome the negative cash flow real fast. Even without rent appreciation, when OP moves out there should be positive cash flow even with the very high LTV.

To give people an update of my current financial standing / goals: I am 22 and I want to reach financial freedom as soon as possible. I have no debts but relatively small amount of capital as I just started a new, first full-time job. I also do not like the idea of throwing away my money on rent in my area which is ~$1k without gaining any equity. I would like the flexibility to move out in 2+ years (for other potential job opportunities) but if I have to stay in my house just to cover the payments I would not be mad because Austin is the city I love the most. I want to take advantage of being risky because I am young even though people tell me I should keep my risk tolerance low since I don't have that much capital.

Thank you to all the people that have posted above, I learned a lot and I am still working out the financials myself as I'm typing this out.

Originally posted by @Kelvin He :
Originally posted by @Peter M.:

Negative cash flow should only be acceptable when there is another aspect such as flipping or a value add play and generally not for the long term unless you are trying to offset other passive gains. 

Also, as others have said, the 3.5 is not feasible but if you find a lender that will do it please let me know. lol

I'm going to live there for the first 2 years, and be able to lease it out to 2 friends while I'm living there for ~1k each. Then I want the ability to leave and continue leasing it out. Does this change anything?

..."lease it out to 2 friends while I'm living there for ~1k each"? ie. You're effectively only paying $200/m to own it, while your friends are paying $1000/m to just rent! All because you managed to save up 3.5% deposit, and they didn't? (There's a lesson in there somewhere).

That also suggests to me that market rent might be even more than $2k/m?

My question is: why only 2 years? You'll always have to live somewhere. Why not there?...

Originally posted by @Brent Coombs :
Originally posted by @Kelvin He:
Originally posted by @Peter M.:

Negative cash flow should only be acceptable when there is another aspect such as flipping or a value add play and generally not for the long term unless you are trying to offset other passive gains. 

Also, as others have said, the 3.5 is not feasible but if you find a lender that will do it please let me know. lol

I'm going to live there for the first 2 years, and be able to lease it out to 2 friends while I'm living there for ~1k each. Then I want the ability to leave and continue leasing it out. Does this change anything?

..."lease it out to 2 friends while I'm living there for ~1k each"? ie. You're effectively only paying $200/m to own it, while your friends are paying $1000/m to just rent! All because you managed to save up 3.5% deposit, and they didn't? (There's a lesson in there somewhere).

That also suggests to me that market rent might be even more than $2k/m?

My question is: why only 2 years? You'll always have to live somewhere. Why not there?...

They are willing to pay $1000/month because comparable apt. are going for $1.1k+. However this is a short term solution, I am guaranteed profitable the first 2 years, but I/they may want to move out in the future and I have to be flexible in case this happens. If this happens, comparable houses within my area are leasing the whole thing out for ~$2k/mo.

Originally posted by @Dan Heuschele :

@Llewelyn A. did a great job showing the numbers.  Great post as usual.   So I will take a different approach.  

RE Is very localized.  Certain locales are about cash flow, other locales are more appreciation plays.  

In my market a rent to total cost ratio of 0.75% is very good. At 0.75% I can show positive cash flow at non-owner LTV. The OP property is at 0.8%. If it did not have any obvious landlord issues or other issues I would purchase it. The negative cash flow is based on 2 things: 1) the very low down payment (3.5%) 2) OP is actually occupying the property. If OP cash flow projections are correct, OP is living at the property for a $200/month cost basis (the negative cash flow). I do not know many people living somewhere for a $200/month basis.

If OP put 20% like most RE investors, OP would certainly have positive cash flow.  In addition, if OP was not occupying the unit they would have positive cash flow.  

In my market I would purchase this in the blink of an eye and be quite happy. The equity pay down would be gravy. I would expect rent appreciation to overcome the negative cash flow real fast. Even without rent appreciation, when OP moves out there should be positive cash flow even with the very high LTV.

Hey Dan, thank you for your input.

Just to clarify, living with my friends would mean I'm paying $200/month to live there with them, however this is short term (because I/they may move out in 2 years) - then I looked to the market for other houses that are leasing and it's ~$2k a month for the whole house. So that is the part where I'm fuzzy about. What do you think?

Originally posted by @Llewelyn A. :

@Kelvin He

@Dennis M.

Dennis, I want to point out that Kelvin indicated that he is NOT BETTING on Appreciation.

What Kelvin is doing is betting that his 96.5% LTV loan of $240k of a $250k purchase will disappear in 30 years, which it will. That's just Math.

Additionally, he will take a $200 per month loss in the 1st year he rents it out entirely ($2,200 expenses but only approximately $2k in rents).

Let's just assume the above scenarios plays out for the entire 30 year holding period.

So Kelvin will lose $200 per month or $200 x 360 months = $72,000.

Assuming NO APPRECIATION, the mortgage disappears in 30 years.

If Kelvin then sells the property at the same price of $250k, his return would be $250k minus $72k minus $10k for down payment = $168k profit in 30 years.

Considering that Kelvin would only put in $10k as a down payment, $72k as payments towards the property over the 30 years, his investment is $82k which then returns proceeds of $250k.

If we did a non-compounding calculation of ROI we get $168k profit / $82k Invested = 204% in 30 years or 6.8% per year.

If we did a Compounded Rate of return, we get a 6.12% IRR over the 30 years. Here is the IRR Chart:

What Kelvin is saying is that this is the most pessemistic scenario where he will have ZERO Appreciation AND NO CASH FLOW INCREASES due to increasing rents versus expenses.

Kelvin can then come up with an optimistic senario, such as add 5% annual appreciation with 2% annual cash flow growth.

That would supercharge his IRR.

Aside from this, the danger, as others state, is that Kelvin cannot afford the negative 200 per month cash flow. BUT.... common guys... negative 200 per month?! I mean this doesn't kill anyone that I personally know who has disposable income to buy an investment, even for $10k savings like Kelvin.

Of course there are a ton of other considerations such as Capital Expenditures and Tax Savings, but we are not building a very complex and sophisticated spreadsheet just yet. If it were me, I would actually do it.

I would definitely look into the economic factors that are going to be driving the value of the properties in that area as well over the 30 years, however.

To me you can get the numbers completely correct, but if you don't know the economic trends that are happening, a good investment can turn into a nightmare no matter how much cash flow you are generating over the years.

There are too many examples of cash flowing properties that stopped cash flowing such as places like Detroit, Bethlehem, Allentown, etc. Generally one industry towns where the Industry dried up.

The economics is a necessity to long term buy and hold investing. If you are not doing that, good numbers can turn out bad.

But that being said, this is well within my risk tolerance level as long as there are no negative economics that will impact the next 30 years.

 Thank you so much for your input and for going in depth with it. I was very pessimistic about purchasing this house but your post gave me hope.

How risk tolerant do you think I can be? Is it just a personality thing? Or is my financial standing a big influence on this? I am just a 22 year old with no debt and started my first full-time job. I don't have much capital (hence the 3.5% down) and will be putting a lot of my cash into this house. However I want to reach financial independence as soon as possible and I don't want to be throwing away my money on rent which is $1k/mo with no gain in equity.

Originally posted by @Kelvin He :
Originally posted by @Dan Heuschele:

@Llewelyn A. did a great job showing the numbers.  Great post as usual.   So I will take a different approach.  

RE Is very localized.  Certain locales are about cash flow, other locales are more appreciation plays.  

In my market a rent to total cost ratio of 0.75% is very good. At 0.75% I can show positive cash flow at non-owner LTV. The OP property is at 0.8%. If it did not have any obvious landlord issues or other issues I would purchase it. The negative cash flow is based on 2 things: 1) the very low down payment (3.5%) 2) OP is actually occupying the property. If OP cash flow projections are correct, OP is living at the property for a $200/month cost basis (the negative cash flow). I do not know many people living somewhere for a $200/month basis.

If OP put 20% like most RE investors, OP would certainly have positive cash flow.  In addition, if OP was not occupying the unit they would have positive cash flow.  

In my market I would purchase this in the blink of an eye and be quite happy. The equity pay down would be gravy. I would expect rent appreciation to overcome the negative cash flow real fast. Even without rent appreciation, when OP moves out there should be positive cash flow even with the very high LTV.

Hey Dan, thank you for your input.

Just to clarify, living with my friends would mean I'm paying $200/month to live there with them, however this is short term (because I/they may move out in 2 years) - then I looked to the market for other houses that are leasing and it's ~$2k a month for the whole house. So that is the part where I'm fuzzy about. What do you think?

 It seems strange to me that you can get $2k rent while living there and only $2k rent not living there.  I would expect in most markets you would get more rent not living there.  

However, I used the $2k rent in my calculations to derive the 0.8% rent to cost ratio. In my market that is a great ratio. It is above the ratio that I am very confident of positive cash flow with typical investor LTV.

In other markets 0.8% rent to cost ratio could be poor.  

I never recommend paying above value.  However, in my market that is a very good purchase.  In addition, to live somewhere for a $200/month cash basis where apartment rents are over $1k is excellent.  

In my market I purchase that property.  My last purchase had a 0.73% rent to cost ratio and a small value add ($20k to $30k).  I considered it a great purchase in my market.  Two or 3 years ago I would not have considered it.  

For those that claim we are at the top of the market I do not know but I do know timing the market is very difficult.  Statistically it can be shown that most people who try to time the stock market have lower returns than if they had not.  I expect the same is true of trying to time the RE market.  There are big time posters on BP that have predicted a crash for a few years.  So far they have not been right but maybe next month they are correct.  Very few people predicted the last crash prior to it being obvious.  

What I do know is that if the RE continues to appreciate anywhere close to the appreciation on the last 6 years that people who failed to invest now will be kicking themselves.  

Good luck

@Kelvin He I revise my last post now that I see you are living there. Do it. Especially if it is in a good area of Austin. You are living for $200/month! If that fact had been in your original post you probably wouldn't have got half of those negative responses. 

If/When it appreciates to the point that you have more than 20% equity, refinance so you can get out from under PMI and all the other crap attached to FHA loans. (i'm not saying FHA is crap, its a great program to help people get homes but there is a lot of extra insurance because the people applying for them present a bigger risk).