Must all rental properties cash flow?

Question

Hi everybody, first post, thanks for being such a  great resource.

We are looking at buying our first rental, it is a condo in a remote area (remote to us, the area itself is developed)my numbers on the one unit ive looked at.

$160K selling price

1400 net rent

700 monthly fees: HOA/taxes/maintenance/insurance

so it nets about $700 before mortgage and management. if i put 25% down at 3.5% 30yr, monthly payment will be about $540.

The property is currently being managed at 11% ($165). If i add that on, cash flow is basically zero, but the mortgage is covered. This is allowing for maintenance expenses based on previous owner's history ($300-$600/yr).

Assuming 3% appreciation in the property per year, and the equity that would increase from paying down the mortgage, this $40K investment would return over 15%/year in the  first few years. enough that i could have enough to refi a second property of similar economics in about 4 years. (Thats not our only investment, we are in a position to buy a few of these at these terms in the next few years. maybe target 1 a year out of our current income without tapping the equity of the existing rentals)

A few notes: this is in an area we ultimately want to retire to, and are looking to accumulate more properties in this complex/area, to ultimately have 5-10 units in over the next 5-10 years. We are trying to keep it simple, but 10 units could provide level 1 independence for us (and our primary residence will be paid off by then, its a pretty lateral move). Once we move there i would take on the property management to increase revenue.

thoughts? i saw this article here about the woes of no cash flow

https://www.biggerpockets.com/...

but not sure if its really applicable to us. While there may be better rentals which cash flow *and* build equity, is one like this which only builds equity but doesnt cash flow a deal killer?

TBH there are probably better deals out there, but in our specific situation (limited amount to invest right now, self employed, first property, trying to keep risk low) this seems like a fit. Its basically our training wheels property, low downside, and if it works as expected we buy more similar ones and increase our portfolio a little at a time. We would like to eventually get some nicer short-term rentals in same area but those are out of our budget for now and the lender requirements are higher % down as well. And then there is the risk of low occupancy, etc. Perhaps down the road when we arent rookies and have better lender relationships

thanks!

Nathan Gesner · Answer

I think you're trying too hard to make the deal work. If it doesn't cash flow, you're betting on equity which is a gamble. The market has been growing for ten years and recently has gone nuts. I wouldn't recommend playing the equity game when we're likely in a peak market.

Different markets behave differently, but my experience shows that condos don't appreciate the way a single-family does, and condos tend to have growing expenses and other issues. What will you do if there's no cash flow and the HOA decides to hit everyone with a special assessment or raise the dues? And the market slows/drops at the same time? Or the rental market dries up and you're stuck with a vacancy or have to lower your rent price $200 a month to keep it filled?

It doesn't sound like a good investment to me.

Ryan Howell · Answer

I agree with @Nathan G..  In general, I see it as your wealth comes from the appreciation, i.e. playing offense, but your cash flow is your defense.  It protects you so you can hold the property long term to realize that wealth benefit.  If it doesn't cash flow, how does that help you achieve level 1 independence?  If you had ten properties like this and rents dropped 10% for some reason, you're further from independence than you were. I assume you need cash flow to step towards that goal?  If you had ten properties like this and rents dropped 10% for some reason, you're further from independence than you were.Now, if you had ten properties or so, all cash flowing really well and you have an opportunity to buy a property in a GREAT area for appreciation, it would be different, as you could take more risk by looking at your overall portfolio cash flow, but I wouldn't do that starting out.  Starting out, in my mind, the keys to being a successful investor is learning to be patient, find solid, good cash-flowing deals and learn how to recognize them.

I will say there is one exception, and that is if you have very high income and no free time, then I would sacrifice your cash on cash return and leave more money in the deal to make it cash flow.  Then you can pay more retail prices, but spend less time hunting, but you're still ensure the property cash flows.

Antonio Cucciniello · Answer

@Jamie Lynch In the end this comes down to your preference and standards. Personally, I would not buy something just for appreciation and no cash flow, but I know people that do it and are successful. I just think you are making a much riskier move when you do that. Because if you count on equity in a down turn, then you are not in a good position.

In my opinion (for whatever that is worth) investing is part protection of a downside and a potential upside. Cash flow provides both.

Eric Meinnert · Answer

My two cents would be to look into house hacking, especially if you know you want to retire there. If real estate can teach us anything, its that the answer is never not, maybe just instead not yet, or pull more people into it. My wife and I have a STR, and we never inteded for it to be, but after living in it for 7 years as our primary residence, the opportunity presented itself to move, but keep the home on a 30 year mortgage. 7 years ago I had no interest in real estate, but after househacking without recognizing I was doing so, we have equity, a great fixed rate, and the security that we aren't going to go upside down or backwards on that property, so we can scale if desired. But, I couldn't have done it without househacking.

Nick Barlow · Answer

@Jamie Lynch “success stories” are more harm than good in my opinion...they give unrealistic expectations. It’s the investor equivalent of “keeping up with the Jones”

Unless you are willing to do as much work, or more, than those writing them, it’s been my experience they’ll leave you envious.

It takes some serious hustle in this market to find deals-more than I have the time to do with a W2, spouse, kids, rentals, and the thought of occasional non productive free time.

To your question-there are times a cash flow nuetral is acceptable. In my opinion, it’s definitely not the first 2-3 deals or the first 2-3 years. After that, you’ll know the criteria for you. Good luck!

Allen Wu · Answer

Jamie,

It depends on your goals. In 2015, I had not discovered BP yet, so shot from my hip. My wife (girlfriend then) and I scrapped up our savings and each bought a condo in the LA area. We lived in our respective condo and rented it out after a few years due to job change. In short, rental price at that time was able to cover our mortgage, hoa, and property taxes. We broke even but had to accrue for reserves etc. So we did not technically break even. Overall, we got lucky and both these properties have huge equity on it, and now cash flowing. Would I do it again? Probably not. I would focus on cash flow with slight appreciation. Lastly, who knows. We were just action oriented and even if we lost money, we treated these units as a mini pension, so when we pay off in next 20 years, it’ll just pay us a steady flow of income vs. us wasting money on consumer stuff since we are natural spenders.

So not the best answer but hope my story or rational is helpful. Good luck!

Jason Shackleton · Answer

Hey @Jamie Lynch Does every rental property need to cash flow? No, but it is much better if they do. I agree with @Nathan G. here. We are likely at the top of the market cycle and we have not seen a real correction in a long time. That being said you do not want to buy a neutral cash flow property or a negative cash flow property at a the peak. Cash flow would really be your only defense in a correction senerio. The cash flow is what will allow you to hold through different market cycles. No matter what the price of the asset is you are getting paid every month and that will keep you away from negative outcomes.

I also don't want to stop you from taking action either. This can be situational. Many of the above investors are amazing at what they do. They also have a very large pipeline of deals to look at. If you are someone that views a deal every couple years or so I may advise you still take action on a deal like this. You will be getting mortgage paydown and turning into an investor. Also if you have the time and skills to increase the rents and properties value it could be a play.

My first property did not cash flow but through renovations and changing it's use it now cash flows huge. Action was key for me. But you can take action on another deal.

Good Luck

Loren Clive · Answer

@Carlos Ptriawan nah. I only buy cash flowing properties here in Hawaii. But please keep telling people that!

@jamie lynch you must be shopping on the Big Island at that price point? I might hold out and wait for a house. I can connect you with an awesome realtor on the E side who can help.

Greg Farabaugh · Answer

I have a very similar experience to what @Allen Wu mentions here, been running a condo rental for ~11yrs now.  The biggest expense increase I've seen over the years has come from the HOA going up about every year.  When your numbers are tight on the margins even a 5% HOA bump can have an impact, especially when it happens most years.

Tim Delaney · Answer

@Jamie Lynch ultimately it’s your decision on what makes you feel comfortable, however personally this doesn’t look like a great deal. I’m also not sure about your numbers: $540 (P&I) plus $700 (HOA) plus $165 (management) equals $1405/month. That leaves no allowance for any maintenance or capex.

Also, I’m not familiar with investing in condos or homes with HOAs, but I do know that you have to be aware that they sometimes have large assessments come up. If it’s time for a new roof, or parking lot or if tenants vote on some other type of large capital project you could be on the hook for thousands of dollars - that could kill even a cash flowing investment. HOAs could also change the rules down the road and not allow rentals which could cause you problems.

Lastly, you used the word “Assuming” when talking about appreciation. Why are you assuming that it will go up at 3%? What does the historical data on the building show? What about the area? What happens to your plan if it is only 2%? Or maybe if it’s 6% the lack of cash flow isn’t as crucial. You will also want to make sure the rental market is appreciating at the same or a higher rate - if you cash out refi into a higher payment and rent doesn’t go up then you are even deeper in the hole every month.

There are deals to be had out there even in this market, but don’t force something just because you are having trouble finding a deal.

Must all rental properties cash flow?

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