What would you do?

[Kevin S.]

Hi BP members,

I am looking to invest in a SFH that cost about $400,000. With 20% down the property will negative cash flow $500/mo. It breaks even @40% down. One lender advised me it's better to negative cash flow if I can afford it and still do 20% instead of 40%.

Reason : the additional 20% or $80,000 is better spent towards down for another property (provided of course I can afford twice the negative cash flow) because the annual appreciation @ 5% (which is likely in Florida) will be greater than the negative cash flow per year.  That is $6000 negative cash flow for $20,000 appreciation in return.  That is still a 17.5% return(capex not included).  I don't discount the possibility that the lender gets to finance 2 properties instead of just one but the proposition does make sense on paper and in theory. Does anyone refute this or agree with it?  Am I missing anything?  Thanks in advance.

[Theo Hicks]

Let's say you get your 5% appreciation and sell after 1 year. You will be hit a 6% agent fee. $420,000 sale price is a $24,000. So $396,000 is left. Pay off mortgage of $320,000 and you are left with $76,000. But you put $80,000 down. So it's a $4,000 loss at sale. Plus the $6,000 in negative cash flow, so a $10,000 loss.

Sale after two years at 5% appreciation per year is a $441,000 sale price. 6% agent fee is $26,460. So $414,540 is left. Pay off mortgage of $320,000 and you are left with $94,540. You invested $80,000, so $14,540 profit at sale. Plus the $12,000 in negative cash flow, so $2,500 profit. Which is a 1.5% ARR.

And that is best case scenario. Doesn't account for vacancy, unexpected maintenance, incorrect underwriting, etc.