Rental properties in California

[Bhavya Shah]

Hi team, 

I am a noob when it comes to real estate investing. I am looking for my first rental property and looking around in the California area since thats where I come from. I started looking at some properties in San Diego area but I am quickly realizing that none of the properties I am looking at return positive cash flow. How are people startegizing to buy and rent out properties in california's metropolitan cities? 

Secondly, I am looking at negative cash flow of around $500-$800. Has anyone ever bought a property that was negative cash flow? If so, what were your reasons for doing so?

Thank you for your time!

[Dan H.]

Originally posted by @Bhavya Shah:

Hi team, 

I am a noob when it comes to real estate investing. I am looking for my first rental property and looking around in the California area since thats where I come from. I started looking at some properties in San Diego area but I am quickly realizing that none of the properties I am looking at return positive cash flow. How are people startegizing to buy and rent out properties in california's metropolitan cities? 

Secondly, I am looking at negative cash flow of around $500-$800. Has anyone ever bought a property that was negative cash flow? If so, what were your reasons for doing so?

Thank you for your time!

I suspect your cash flow projection is fairly accurate for the average San Diego RE.  These are not what the successful San Diego RE investors are purchasing.  

Some advice:

• Find yourself a good investor RE agent.  Ideally someone that invests themselves.  Note, I am not an agent.
• Learn to identify opportunities. All markets have opportunities. Whether it is the 1200' workshop that already has plumbing and electrical (convert to ADU for much less cost than usual), a motivated seller that has an issue that you can solve for them, a purchase that for some reason has elevated risk (weigh the risk reward scenario) such as unpermitted unit, a killer BRRRR RE, a RE with under utilized zoning, etc. Basically there are a lot of different types of opportunities.
• Cash flow is one source of the RE return.  Be careful judging a property based on just one source of the return.

>Has anyone ever bought a property that was negative cash flow? If so, what were your reasons for doing so?

I have yet to purchase a property that with my pro forma indicated negative cash flow, but I have purchased twice with my pro forma showing cash neutral and I would not be adverse to purchasing a property with negative cash flow.  Here is some of my thoughts: 

• You may need cash flow to pay the bills, but if you do not you should be concentrating on total return.  
• A property with one of those opportunities listed above can provide instant equity gain while allowing a refinance to extract out the initial investment.  This allows scaling much quicker than cash flow.
• The appreciation in San Diego RE has historically far outpaced the great cash flow markets return from cash flow.  How much so?  I have quite a few properties with various hold lengths and purchased with poor timing and great timing.  My worst appreciating RE has appreciated $2k/month over a long hold period.  There are two ways to judge best appreciating RE, the one that has appreciated the most or the one that has appreciated the most for its hold length.  our highest appreciating property has appreciated $4.5k/month over its 19 year hold.  The fastest appreciation for the hold period has appreciated $6k/month over its 12 month hold.  I do not know how the appreciation will be in the short term (as indicated I have purchased before and the prices declined after purchase), but I have a lot of confidence that the long term appreciation will exceed inflation.
• I have a lot of confidence in continuing high rent appreciation. This is not just because of history. It is because the RE has risen faster than the rents which implies that the rents are going to be in catch up mode for quite a while. The various Covid rent moratoriums identified a new risk to LL. New risks need increased margins to justify. The fed has already announced that interest rates will increase this year. This will drive up the true cost of purchase which is likely to cause further rent increases. I suspect we have at least 5 years of high rent appreciation. This will improve the cash flow each year. A negative cash flow property will quickly become cash neutral and soon will have some decent cash flow. If not refinanced to extract value, it will eventually have cash flow that is incredible. All of my properties meet the 1% rule (rents exceed 1% of purchase price). Some of our properties exceed the 2% rule. One STR in 2019 had rents at 4% of purchase (tough comparing STR to LTR, and 2020 was poor and 2021 still had not caught up to 2019). meeting the 1% and 2% rules is due to rent appreciation.
• Cash flow is a single source of profit.  Because I do not need the cash flow to pay my bills I rank it very low on my desired list.  Cash flow is taxed annually.  Cash flow is a slow way to accumulate revenue to scale.  Cash flow historically pales in return compared to appreciation

Every market had deals to make/find.  Learn to identify the opportunities and you will see there are many opportunities.

Good luck