Is no cash flow okay if I put no money down?

[Ernie Sturzinger]

I'm looking for some constructive feedback on whether this makes any sense or not. I am looking to purchase a 12 unit apartment building in Ohio and I am putting no money down out of my pocket. I have done the analysis and after setting aside 5% for vacancies 5% for repairs 5% for cap X and paid all of the expenses and loan payback money on a monthly basis from my from my investment account that I am leveraging for my down payment loan, I will have no cash flow technically. I am leveraging my investment account with a loan from my investment company for my entire down payment so technically I have no cash going out of my pocket. Does this make sense to still go through with even though I will have no cash flow initially and I will still be able to add a 12 unit apartment property to my portfolio that is presently consisting of one triplex? I obviously want to maximize my cash flow and return but I'm having difficulty finding a highly cash flow oriented property that is within my price range of 300000 to $400000. So this seemed like a reasonable option. Would appreciate any thoughts and feedback here. Thank you,

[Bill F.]

@Ernie Sturzinger

Let me make sure I'm getting this right. 

You have the opportunity to buy a 12 unit that currently has 11 units filled and 1 vacant. You will get some sort of "normal" loan, for the sake of argument 20% down. To fund the down payment you will take a margin loan on your investment account that will cover the 20% down payment. 

At the properties current run rate, after accounting for Operational Expense [ taxes, maintenance, turnover costs, advertising] and Debt servicing [ the principal and interest on the normal loan and some sort of payback on the margin loan] your cash flow is break even. 

If those facts are correct here are my questions. 

1. What are your goals? Do you need the cash flow or can you rely on the other three wealth generators [ debt pay down, appreciation, and tax savings] to generate your return? 

2. If this is an appreciation play, how do you intended to add value? If you intended to simply buy and hold for 15-20 years? If that's the case, when will your major CapEx events come? Two years, five years, ten years ect?

3. When will you start to cash flow and what assumptions have to hold true for that to happen? Will rent growth be that driver and if it is can your tenant base sustain the rent increases? What would your cashflow be if you didn't use a margin loan? 

3.b When will you pay off the margin loan? Are you just paying of the interest portion of have you set up your own amortization schedule? 

4. this is where BP's favorite calculation, Cash on Cash flaws woefully short. Since you have $0 out of pocket, your CoC is infinite. So you'll need another return metric. My first filter would be comparing the cap rate of the property [this is basically the operating margin of the asset] with your weighted average interest rate [ for example if you borrow $80k @ 3% and $20k @ 9% your effective interest rate is 5%] If your effective interest rate is higher than your Cap Rate, the investment doesn't make sense, at least in the short term. If it passes that test you'll have to some sort of NPV calculation to figure out how much you'll make from all the wealth generators.

5. As @Steve Vaughan alluded to, what will the house surplus on your margin account be? If you getting the loan takes you all the way to the house limit, then any drop in the value of your portfolio will result in a margin call. How much can your portfolio fall in value before you get called?  If you can fall 50% then that's a much different than if its 10%

In short, I'd think about this in two parts. First the deal. On its own does it meet with your return requirements and does it fit within your strategy. Second, I'd think long and hard about your financing strategy and how it supports or adds risk to your operational strategy.

There isn't enough info to comment on the quality of the asset, but your financing adds lots of complexity, which isn't bad per se, as long as you understand how putting no money down impacts your plan. The tools commonly talked about on BP aren't enough to figure that out, so you'll have to get a bit more advanced.  But none of that matters if the asset is a POS to start with.