Noob question: Ok to buy negative cash flow but build equity?

[Mark Kohn]

Hi all,

Looking to get into real estate investing and have a super basic question but I couldn't really find an answer so please bear with me!

I see lots of information around cash flow and the importance of cash flow in owning rental properties and analysis for investment/purchasing. My question is, why isn't it smart to buy cash flow negative properties that are still paying down your principe and building equity for you- assuming you have the cash to support? For example, if the cash flow is -$200/month but the tenant is paying down your mortgage, isn't there a value to that from an investment perspective? If so, what is a reasonable loss per month to tolerate to build this equity? $100/mo, $200/mo? In this example I would be paying $2,400 per year to own this property to get all of the deductions and build equity in the property? Not particularly concerned with appreciation.

For perspective, I live in southern California and find it hard to find cash flow positive properties based on todays price. I'm investing for long term wealth, not to replace my current full time job income.

Thanks in advance for any insight!

[Kevin Hunter]

@Mark Kohn, this is a great question and a very polarizing one.  A lot of people on BP will tell you that cash flow is must and any deal that doesn't cash flow is a bad one.  My opinion is that is has everything to do with you and your goals.  Additionally the answer lies in what you need right now.  Can you afford to be cash flow negative?  Do you need the supplemental income in the form of cash flow to survive.  If not, then you are in a different situation.  Cash flow is one way that folks make money on investment properties.  The other three ways are 1. tax breaks (a. depreciation and b. repairs, improvements, real estate tax are all income tax deductions) 2. equity build-up through principal pay down, and 3. appreciation.  When folks only focus on cash flow, I believe they are missing out on opportunities.

So, to now answer your question, yes there is value from an investment perspective if someone else pays down your mortgage and you are cash flow negative.  What you should look at is the cash on cash return.  If you are paying $200 out of pocket each month, and your tenant is covering the rest, how much principal is being paid down.  What is it costing you ($200) to pay down how much ($XXX principal) per month.  If you are comfortable with that return, then go for it.

Second, what are your long term goals?  Do you want a large portfolio to build financial freedom, do you want a couple of properties to supplement the income from your W9?  Do you want to use individuals properties over time to scale to large multi-family or commercial properties? All of these answers will help inform the level of risk you take right now.

Hope this helps a little bit.  I am happy to answer any other questions with only my opinion.  Feel free to reach out.  Good luck!