When to Sell Negative Cash Flow Property?

Question

Hello,

This is my first day after discovering BiggerPockets! I wish I would have found it sooner. I have a question for the community

Last year I purchased a single family home in San Diego when I was traveling back and forth for work. Now that I am 100% in Arizona, I decided to rent the San Diego property as my first rental.

I did not purchase this property with rental cash flow in mind. The difference between my mortgage payment and rent is about -750 per month. After expenses/repairs/property management fees I'm negative about 1200 each month. I was able to find reliable renters at the upper end of what is reasonable for the location and size and don't think I can increase rent. After using the calculator on this site it seems very unlikely I will be able to have it be positive cash flow without paying a significant amount of the loan off and then refinancing to get the monthly mortgage payments down.

The house was purchased as a foreclosure for 745k with 10% down. It was worth close to 900k at the top of the bubble. Its walking distance to the bay and a short bike ride to the beach. Overall I think the house will continue to appreciate and It won't be hard to find renters. Currently the rent is enough to cover the interest on the loan and some of the principle, so my equity in the home is increased.

I am trying to decide to keep this negative cash flow, but positive equity property, or to sell and use the close to 100K equity in as a downpayment for a multifamily home in town. If I hold this San Diego property long enough to have it paid off (which I could probably do in 15 years) then it would generate close to 3K a month in rental income

I'm lucky that my wife and I both have high income jobs and the 1200 dollar loss a month is less than 4% of our monthly income.

What would you all do?

Justin R. · Answer

@Doug Doehrman Welcome to BP!

Same advice as always - let the numbers do the talking and leave the opinions for after a glass of wine.  :)  Investments come down to options - do YOU have a better option than what you're currently doing?  Let's dive in on this option.

You mentioned that you have at least two other sources of high income, so I'll assume cash flow management isn't the challenge - wealth generation is.  Further, I'll assume your numbers include a Capex reserve and you implied your NOI is essentially $0 on the property.

Figure out how conservative or aggressive you want to project.  I'll claim the most logical scenario is the property value will track inflation over time.  I'll assume a 10 year inflation rate of 2%.

Hold the Property

I didn't run the IRR, so this is just back of napkin, but your average annual gain over a 10 year period if you sold after that would project at ~$15k.  Your total capital in is $75k, for a projected ROI of about 20% annually (minus transaction costs at sale).

Now, risk adjust that.  How likely is it that inflation will be 2%?  How likely is it that the home's value will track it?  How likely is it you'll have additional capital outlays?  How likely is it that your expense estimates are accurate?  How likely is it rents will stay at the current level?  This is your call, but I'll assume a (-8%) risk adjustment.

If you hold, you're looking at a 12% annual return on your money.

Sell the Property

I also didn't run the IRR here, but let's assume you can sell and walk away after all costs with $100k.  Assume you declared it as your principal residence for two years, so that's tax free.  You've now got a chunk of cash that you need to earn a risk-adjusted return of at least 12%/yr over 10 years.  Is something like that available to you?

It's difficult to take two investments and build a model that allows for true comparison between them - there's always some amount of adjustment needed based on necessary assumptions.  But, the most important thing is to always look at these things in relative terms: "Relative to other opportunities available to me, how will this investment likely perform?"  Establish the universe of available alternatives based on your desired lifestyle and comfort with risk ... then just do the numbers.  Numbers never lie.

Good luck, and let us know what you decide to do!

Anton Mattli · Answer

Assuming that your home really is worth as much as you believe it is, such home seems to be in a submarket with very few renters (i.e. most people moving into the area have the financial means to buy instead of rent) so you have a very small pool of potential renters to choose from which depresses rents in that submarket. In this case, and assuming that you do not plan to move back, I would sell immediately and reinvest the freed-up equity in a cash flowing opportunity.

Patrick Liska · Answer

I never invest on the hopes of Appreciation, it needs to cash flow or in your case, you buy low as a foreclosure and sell for more, because it IS worth more. If you have 100,000 equity, i'm assuming its worth about 750,000, by the time you take out realtor fees you may end up with close to 50,000 before tax. when will the property Appreciate ? 5 years, 7 years ? no one can tell you, so each year you wait for it to appreciate, you loose money every year, not quite 14,400 as mentioned above because of depreciation and deductions, but it is costing you. you can look at it as you bought the house at a good price and now you are selling it and making some money on it - i'm sure it will even be less after you subtract what it's been costing you every month. but it may be time to get rid of it and cut your losses, unless you know something or someone here knows something positive about the upcoming market there.

Denny Robert · Answer

Man sorry to hear about the situation. Hope it's a better overall job/business!

I would get out of that thing so fast, but you're gonna take a hit on the resale. Now granted, it isn't hurting you much to hold it with your current salaries, but why hold it if you don't need it and it's not a great investment? It's going to cost you at least $14,400 a year, assuming no maintenance or repairs are needed. If the market continues an upward trend you'll make a few thousand dollars a year. It will take years to make a return on your down payment. Also, a lot of people are talking about an overall market shift coming in the next couple years. No one is a perfect genie, but you could end up losing the equity you have in it, be in negative equity on a negative cash flowing property and having to pay to sell!

If you have any questions or need any help don't hesitate to reach out!

When to Sell Negative Cash Flow Property?

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