Negative cash flow deal - Would you buy it?

Question

My debate is this.

As a general statement the rental property cash flow here in Los Angeles is VERY challenging to find.

I am looking to buy a property with a detached garage and convert into and ADU for helping to offset to mortgage.

Crunching some numbers up on $1M property with and ADU assuming (rough numbers) main house brings $5,000 and the ADU $2,000 I’ll still be negative in the deal after all expenses (vacancy, capex, repairs etc…)

However if I will use it as a Sort Term Rental it will be cash flowing beautifully.

What’s your take about buying negative cash flow long term but counting on AirBNB to bring in the positive cash flow?

I appreciate any opinion and advice.

Dale K Poyser · Answer

Don't run numbers based on STR or MTR, run the numbers based on the worse case scenario which would be LTR. If you are comfortable with those numbers and you can wait it out until interest rates improve then go for it.

You could also consider putting down a larger downpayment. There are downpayment assistance programs in CA that are in play. One of these programs will give you funding up to 150k toward the downpayment. That program coupled with some other incentives (like rate buydowns) may move the needle in your favor.

The program is called "dream for all"

https://www.calhfa.ca.gov/dream/

Jonathan Greene · Answer

You won't be able to circumvent the STR rules in LA unless you live in the primary where the ADU is I don't think. Buying into negative cash flow in hot markets is fine, but I think it's safer for house hackers and not for investors. If STR is your only way to go positive, you can't rely on that. Also, if there is room for an ADU renovation, with the new laws, someone is going to pay more and put more units back there if they can.

Austin Steed · Answer

It all depends on the appreciation potential of the property. If you're buying in a city with strong job and population growth it could work. Too often I see people buy in rough parts of a city as the numbers pencil out. In the end with turnover, vacancies and repairs the property doesn't even make money. With debt service being higher now, it's better to be in good locations in good cities to me!

I'm in Columbus Oh and we have great job and population growth. For my personal portfolio I want to look back 10 years from now and be happy with the locations I decided to buy in.

Mike Paolucci · Answer

Hi @Eilon Shoham, in my opinion, if it doesn't make money, it doesn't make sense. You also have to take into account the local / state landlord laws...especially the ones coming down the pike in CA's November ballot --> "Justice for Renters Act" Not sure if it'll effect STR or MTR but as a general rule of thumb, I don't run numbers on best case scenario. I also don't believe that an asset should be costing you money every month.

If you're open to the idea of OOS investing, check out the Ohio markets (Columbus, Cleveland, Cincinnati, Toledo, ect.) When I was living in CA an started investing back in 2021, the numbers and landlord laws made sense for me and they still do today. Assets are there to make you money, not cost you money.

Let me know if you have any questions. Happy to help out.

Bradley Buxton · Answer

@Eilon Shoham

STR and MTR can be profitable with the right business plan.  If you've never set one up, don't know the competition, or don't have the capital to absorb the vacancy it will be a tough strategy.  Each individual deal is different and if you are looking for appreciation and you're losing $50 per month and the appreciation is 10,000 per year then it might be a good investment. Can your income sustain the loss and when will it cash flow?  Can you find something different in a lower cost area that is hours away that does cashflow? There are many CA investors that invest in places like Sacramento, or a bit farther like around Reno, NV because it's close, the cost of properties is lower and only a few hours flight or drive. Nevada has lower taxes and more landlord friendly without the hassle of traveling to the midwest.

Sam McCormack · Answer

People make negative cash flowing investments seem like the worst thing on earth. Granted I don't know laws there, people in general make negative cash flow for a year or 2 in a GREAT area, the worst thing ever

Nathan Gesner · Answer

I don't recommend it unless you are an experienced investor who understands the risks and how to overcome them for the next 5+ years.

We hit a peak market in 2023. In the next 3-5 years, the market is more likely to stagnate or decline than increase sales prices. If you are in a negative cashflow today, you are unlikely to grow into a positive cashflow for several years. If you lose equity on top of that, there's no escape.

Marcus Auerbach · Answer

There are degrees of negative cash flow. LA cash flow is certainly deep red. The type of properties we tend to buy in Milwaukee are just over break even in my book, but you could easily call them negative cash flow if you start adding percentages for reserves. I buy them because they will be very good properties to own in 10 years from now.

Cashflow has always to be considered in the context of the quality of the investment. Most investments I see that are positive cash flow out of the gate come with a substantial amount of future capex. Especially in a city like Milwaukee where a lot of houses are between 60 and 120 years old.

But we also have a chronic housing shortage, which is driving up prices and rents. And because we have very little new construction, the inventory that we have today is basically all we will have at least for the next 3-5 years. Meanwhile, more people move here because of the attractive cost of living, Midwest lifestyle and stable climate. That's why I am buying breakeven properties.

Joseph Bui · Answer

I'm usually not a proponent of cash flow negative deals (assuming 20% down and calculating putting aside at least 15% for maintenance/vacancy/capex). This is for a couple reasons:

1. Really sucks to lose money every month when you just shelled out a large chunk of money, in this case 200k.

2. What if there is an emergency, personal or with the property? Job loss, burst pipe, etc. If anything like this happens, you are in a really tough situation as you will need to go deeper into your pocket.

3. The main reason people do this is because they believe it will appreciate over time. It will, of course I believe this or else I wouldn't be investing in real estate. However, when? We have no idea. Its a weird market. Nobody can predict if/when. What I do know is there are plenty of other markets in the Midwest (I have 9 doors across Memphis and Detroit) that will cash flow immediately and based on the data I'm seeing, has appreciated more than areas like LA/Seattle/Bay Area in the last 5 years.

You also bring up airbnb which is a viable option to cash flow. Plenty of people do it. However, it suddenly becomes much less passive and with city governments starting to crack down on it, its now a very risky solution long term.

Happy to connect and chat more

Travis Main · Answer

I would never advise a client to buy a LTR if the LTR income doesn't cover the mortgage balance. We have seen and still continue to see the crackdown on STRs. If states and counties implementing new restrictions on use of the property, I would advise against this.

Negative cash flow deal - Would you buy it?

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