Why is my cash flow in the negatives? Is this a bad investment?

Question

So I'm looking into buying this rental property that just came on the market by a University. It is a 3 BR 3 BATH apartment Unit and the market is hot for these here and they sell quickly so I did my analysis, included all the things like capex, repairs, whatnot, and still come up negative. I know the rent price is fair market value and common sense tells me I should be getting cash flow but math does not, am I pricing CAPEX, repairs a little too high? What are your thoughts based on my calculation?

Andrew Johnson · Answer

@Peter Kim Oh, and not to jump on with a further potential challenge but you'll want to inquire about the health of the HOA. Some are run extremely lean (i.e. they keep HOA fees low-ish) but they do moderately frequent "special assessments". Repair an elevator? Assessment. Repair the exterior? Assessment. Resurface the condo pool? Assessment. Restripe the parking lot? Assessment. They aren't optional. Some HOAs bake all of that into monthly fees and others don't. If the building/complex has *any* signs of deferred maintenance, odds are you'll get an assessment even if the HOA bank seems healthy.

Andrew Johnson · Answer

Peter Kim So two flaws... 1.) You're analyzing the deal with 15% down. Most investments require 25% down. Rerun your numbers with 25% down so you're at least analyzing this in a like-for-like scenario. Side note, it's also why the 3.5% down FHA deals often have trouble cash-flowing. 2.) Not all properties are meant to be cash-flowing investment properties. Condos are even tougher because of HOA fees, restriction on the % of rentals, etc. Not to mention if you're selling in an area with owner-occupants they aren't seeking a return. Basically, not all properties are meant to be investments. Not all "investment" properties are meant to cash-flow the first day you buy it. I look at my SFR in Encinitas (where I live) and I'd bleed cash like a stuck pig if I tried to rent it out. And while it's great that you're qualified for a 15% down mortgage, you're better off using 25% down if you're looking at an investment. I hope that helps, it probably doesn't... 🤷🏻‍♂️

Joseph Pugliese · Answer

@Andrew Johnson I totally agree with you , I purchased properties with no cash flow but great appreciation, in NYC cape rate are low and seem to be getting lower lol. Believe you really want want on investment properties that have a few doors and not just one , if that one person is not paying, your investment is losing 100 percent, oppose to 2-4 doors, minimizing your loss. Also I believe now FHA is down too 3 percent . @Peter Kim Good rule to keep in mind , if your tentant is paying , you should be able to cover the Full operating costs, if not you're playing with scared money. my 2 cents ...

Joel Owens · Answer

HOA's can be bad news. Try to stay away from those as an investment if you can. Where my office building is there are various property owners. The HOA was run first by someone who did not do well with the money, then by a PM company who used their repair people and were charging triple the rate, and now one of the other owners and he is doing a great job so far.I had a chance to buy many more office units in there for investments but I do not want to do deal with a COA (condo owner association) on a larger level than I already am. We have pretty much new parking lot, newer roofs, all brick buildings, etc. so our office park is one of the nicest in the county.

Joel Owens · Answer

Before at the bottom of the cycle you could buy something and even with little rent income ride the equity wave up and as markets got stronger rents went way up. These days it seems prices are way over inflated and renters are facing being maxed out in rent versus their income. Down here in GA some older units were at 600 a month 5 years ago and now 900 a month. The tenants on these incomes cannot support or sustain more rent jumps like that with their income. So what happens is a leveling out of rents to hopefully keep up with inflation so your dollar by dollar return doesn't weaken year over year.You are likely going to have to find something off market that is value add where you can increase the equity value and get a very nice all in rent to total costs to stabilize ratio.I do not focus on residential but I looked for fun yesterday in GA at thousands of listings online and everything sub 200 in price was trash I would never buy. I am seeing a cycle topping out like I did last time in 2007,2008 for residential. Maybe attend some local investor meetings and find some older investors that do not want to 1031 exchange and would sell to you and take payments over time with little down like 10% etc. Typically easier to qualify for than a bank and less red tape.

Brian Corbett · Answer

@Peter Kim I am very familiar with the unit that you are speaking about and your numbers are dead on. Personally, I would not buy a negative cash flowing unit just because it will stay rented (hopefully). I can assure you, with the right property manager, your vacancies can be minimalized. The HOA is terribly expensice especially since it doesn't offer any real amenities to the tenants such as pool, tennis, etc. These amenities are not too beneficial to an investor except they can help increase the rent amount. Without the amenities, I don't see the rents getting much higher than they are now.

Account Closed · Answer

If your estimations were correct in terms of rent and operating expense, then it seems like a bad deal. For starts, just the operating expense is almost 65% of rent. Normally, 50% (per the 50% rule) can be excessive in some markets but still 65% expenses and prior to adding debt service, will almost make CF negative in most markets.

Account Closed · Answer

I think if the property is really good it should cash flow with 10, 5 or 0% down. If you have to increase the down just for property to cash flow, then there may be something wrong. He may just have to find a better deal that CFs with at the 15% or a lower amount. Of course if the lender says you need a certain percentage down to get the loan, then thats what your options are. It is true that not all properties are meant for CF. The 1% rule work in some markets and with certain properties and it doesnt in some.

Account Closed · Answer

The problem is you are including debt service (mortgage payment) as an operating expense. You subtract that and you should have expenses at $485, cash flow $265 and cap rate at 4.54%. It does mean however (if your numbers were correct), that you would have the out of pocket expense of $55.09 each month. This is a problem often more pronounced in markets like LA or SF.

Chris Martin · Answer

The insurance is about right since it is an HOA-6 policy that covers LL liability and interior depending on how the condo declaration is defined. In NC, common area and limited common areas are covered by the master policy and that 'fee' is covered by HOA dues. I typically look for 1.5% of Basis as a monthly revenue rule of thumb and my company's acquisition 3 or so months ago in Greenville NC met that metric. It's a Class C 18-unit property, though. As you pointed out, better properties that are in demand in this seller's market will demand better contract pricing. I can introduce you to my PM if you want to compare pricing. Might be a few percent less. As pointed out already, HOA stability is important. Get a list of historic special assessments and get the HOA's balance sheet. Investor density was important historically too, since under 50% Owner-Occupancy Ratio Requirements could impair your ability to sell via FNMA underwriting/financing. I don't know if that's still true today. You can 'cheat' a little on capex with condos in that your main expense is HVAC. Appliance capex is about $1100 over 10 or so years and HVAC is $3300 over 15. $110 + $220 annual, or $25 or so. If your anticipated hold is 5 years or under and HVAC and appliances are newer, then I'd not bother worrying about it unless your financing stipulates reserves. If appliances are over 10 years old, put in new scratch and dent or Habitat products donated from a local rehabber. Keeps from having appliance service calls which are usually 50% or more of a 'new' (or gently used) appliance. It helps a lot if the local HOA has or knows a 'community handyman' who does common work at reasonable fixed rates. Personally, I avoid condos unless I can they cash flow well or I can buy a big enough chunk to influence the HOA fees. My general rule is only buy condos and townhouses in a buyer's market. Also most HOAs are not well run and seldom do boards focus on managing the HOA affairs in a fiscally responsible way. Been there, done that. But that's me and my company's membership. There are exceptions. I hope it works out for you.