For many real estate investors, the ultimate goal of most investment properties is to achieve consistent positive cash flow. Without positive cash flow, your investments are pointless at best and draining your resources at worst. Negative cash flow doesn’t necessarily mean you need to jump ship — but you should plan well if you intend to salvage a property with negative cash flow.
Negative cash flow isn’t always a death sentence. Many skilled investors ride it out until the property has appreciated the value to make up for it or manage to turn their situation around entirely. Many of those same skilled real estate investors are actually purposely purchasing property that will cash flow negatively as part of their strategy. The negative cash flow aspect is simply a cost of doing business as the much bigger play is the appreciation in value or the value add of land, building and process improvement.
However, these are not investors who purchase a property expecting it to cash flow positive only to find themselves in a negative situation. The “accidental” negative cash flow investor is who we are really concentrating on today, and those investors absolutely exist and can recover.
But how? You can’t go into a negative cash flow situation flying blind. Investors would do well to keep their options opens through intentional planning when they find themselves in the weeds of negative cash flow.
Download Your FREE Rental Application Form!
It may seem like a small thing, but having a solid rental application is the first step in finding great tenants. Since BiggerPockets is all about helping you succeed in real estate investing, we’ve put together a complimentary Rental Application for you to use. Download it today and go find some great tenants!
4 Essential Strategies for Dealing with Negative Cash Flow
1. Make Your Business Plan Rock-Solid
You’re nothing without a solid business plan. The last thing a real estate investor should do is acquire a property with the mindset of figuring it out as you go. If you can survive the worst of it, you’ll usually emerge victorious — but don’t gamble on negative cash flow if you don’t have to.
Why is there negative cash flow? How are you going to fix it? Identify these factors and put a plan in place to turn things around. You can’t afford to grope around in the dark.
By the same token, investors would do well to overestimate their costs. You want to leave plenty of buffer in your plan to account for unexpected hiccups and setbacks. While developing a plan of attack, remember to have an exit plan in the wings as well.
I am a huge advocate of investors patiently working their investment plan. It is not enough to simply have a good investment plan. You also have to have the flexibility to change and adapt to a changing investment environment. When a property goes negative, an investor needs to be able to move quickly and adapt. Possibly a different rental class, a change in management or an updating of features is called for. Possibly a property needs to be refinanced into better terms, and at times, a property originally intended for long-term buy and hold needs to be sold — but only when you can make money!
The bottom line for an investor is to quickly assess a situation and put a plan in place to make changes. If you have a solid business plan from the beginning, then a negative cash flow situation can usually be turned around and dealt with minimizing losses.
2. Have Alternatives Up Your Sleeve
Is the traditional model of renting not working for your negative cash flow property? Explore alternatives. You’d be surprised how effective simply changing up how your rental works can be. What kind of alternatives are out there? Here are just a few:
Bed & Breakfast
If your property is big enough, it might be possible to convert it from a run-of-the-mill single family home to a cozy, desirable bed and breakfast. Location, size and aesthetic are big factors here. Not every investor wants to enter this kind of business, which is a departure from the norm for sure. Still, a B&B or holiday rental could be an option for you.
Are you just ready to get rid of a negative cash flow altogether? Consider allowing your tenant to rent-to-own. It could be extremely helpful for them, as they likely are struggling for mortgage approval. Generally, renting to own takes 1-5 years in the short-term. Tenants pay an amount above the market-agreed rent cost, which they receive back as credit when they purchase.
Is your property located near a hospital, business district or university? Offering short-term rentals (and charging slightly above normal for rent in a short-term lease) can not only turn negative into positive cash flow, but also offer a much-needed service in your area. For employees only in town for the duration of a contract or students who need housing on a semester-by-semester basis, short-term leases just might be the answer.
There are plenty of other alternatives to be explored by seasoned investors, many of which can turn a dud into a lucrative endeavor.
3. Have a Cash Reserve Ready
As they say, the best offense is a good defense. How prepared are you to handle negative cash flow? Without cash reserves at the ready, you won’t be equipped to handle long-term investments, which can go from positive to negative as the market changes.
A lack of cash reserves leads to compromise on your part — sub-par repairs, less-than-desirable tenants and generally being strong-armed by your lack of capital. This is the most common mistake that investors make.
That’s why investors should never sink everything into a single investment. You need that cushion to ensure you can make it through tough times without having to compromise your business plans, standards and good judgment.
Related: What to Do About Negative Cash Flow
4. Put Positive Cash Flow to Good Use
When you have positive cash flow on a property, put it to good use. So many times investors immediately put money to work on new watches, new clothes, maybe a vacation or two or some other kind of “toy.” Rarely do investors actually put this money off to the side for a rainy day fund. This causes a major headache for investors if the property suddenly faces a negative cash flow. If that negative instance lasts for an extended period of time, then the investor is in real trouble.
When investors use positive cash flow to reduce principal and fund a rainy day account rather than provide for a lifestyle, it puts them in a position to be very flexible and nimble should the property suddenly be cash flow negative. What is fantastic about this point for me is that an investor can reap the rewards of a property when it is paid for in entirety, and any leverage, which causes a negative cash flow in the first place, is reduced and retired. What I find so attractive about putting positive cash flow to good use is that I can get to a place where a properties cash flow cannot go negative. That is a big deal for me as an investor!
How do you cope with negative cash flow?
Share your tips in the comments!