What to do with negative cash flow property

Question

Hi All (it's my first post),

I'm looking for some ideas on how to improve my situation with my only rental home so I can be in a better position to pick up some more properties.

A few years ago we took out a HELOC on our primarily SFD to finance some land and build a new home. The plan was to sell the old home once we moved to the new home. At the time, market prices would have covered both the initial mortgage and HELOC on the first house but things didnâ€™t workout that way.

So the situation now is I owe 110k on a SFD with P&I and expenses around 1200/mo but property is renting at 800. So Iâ€™ve got a negative cash flow of 400/mo going to this property.

The loans on the home are 15 year loans with about 10 years left. The interest rates are 5.5 for the mortgage and 6.75 for the HELOC.

Recently I started putting most of my extra monthly cash (3k) towards the HELOC to try to pay it down but Iâ€™m questioning the wisdom of this.

Here is what I think my options are:

Cut the property loose? The market value (I looked at comps) is probably just north of 100k so if I sold I would take a little bit of a hit.

Refinance the two the loans into a lower rate roan. REFI costs of about $3k but would lower the monthly payment to about the break even point.

Continue to throw all my extra income on the home. Pays the loan off early.

Any thoughts?

Timothy W. · Answer

Sounds like after all selling fees and everything you'd take a 20k hit to sell. That's around the cost of 4 years of your negative cash flow, give or take. A lot can happen in 4 years. You're 32 and young and even at negative cashflow for the next 30 years, when you're ready to retire, you'll own this free and clear at a cost of another $144,000.00, assuming you never do better than a $400 per month loss for the next 30 years. Will this house be worth $100,000 in 30 years or will it be worth $300,000 - $400,000 or more then? Will a 200,300,400% ROI pay off then? You have the luxury of playing this game young and can suck up young mistakes over a lifetime of learning. Rents can go up or down over the term of a fixed rate loan. The payment of the loan stays fixed.

Paul B. · Answer

There are probably too many variables for someone to give you the correct answer here. If you can refinance and turn thing to break-even, you'll recoup your closing costs ($3K?) in eight months since you won't be losing $400/month any longer. So then the question is, "Is the property worth keeping?" Do you see any upside here? Do you realistically think it will go up in value in the next few years? If so, you might hang on to it since it's cash-flow neutral. Plus, rents should (hopefully) be going up a little every year. One thing we don't know about it, are you equipped to handle something majorly expensive with your rental should it come up? That break-even cash flow looks good right now, but inevitably you're going to have a repair or replacement which will put you at a loss. If you're not equipped to deal with this, then you might consider taking the hit and unloading the property. Since you apparently have several thousand dollars a month in excess income, however, this doesn't sound like it would apply to you. if that's right, then I think your only real question is, will this property appreciate any time soon?

Owen Dashner · Answer

You could have $108K in a savings account if you saved $3K a month for the next 3 years, plus another almost $14,400 ($400/mo. negative cashflow x 36 months) that you wouldn't have spent on negative cashflow/repairs/vacancy/etc. So if you take $122,400 and subtract out the $20K loss you would have to take in order to sell the property right now, you would still have over $100K in cash 3 years from now. Cash is king. Even free and clear properties are not easy to borrow against even if you have a strong balance sheet. Or, if you kept plugging your discretionary income toward the existing property, you mentioned that you could pay it off in 4-5 years. Even after you pay the property off, it is only going to have roughly about $400-500/month cashflow if you use the historical average of 40-50% expenses. So you'll have an illiquid asset worth (roughly) $100K that produces an annual net income of $5000, or 5%. Personally, I'd take the hit, save up some cash and position yourself to snatch up some killer deals as you march toward your goal of 25 properties. If you plow all of your disposable income into one house, you won't have anything left to pounce on good deals. Plus you are going to need leverage of some type to acquire 25 properties anyway, and most lenders want you to have some skin in the game in order to get their cash. There may be others that bank of appreciation, but NOBODY can say with any certainty what the market is going to be like 5 years from now- too many things can happen between now and then. Just my $.02.

Account Closed · Answer

I'd let it go, like the others said. No thought about it.

Mitch Kronowit · Answer

No and No. It depends on your market, but why dump a property today and lock in your loss if you are just a few years from paying it off and enjoying the cash flow from a free and clear rental? Imagine the peace of mind knowing you can wait MONTHS for the right tenant if you had to because you're not writing the bank a check every month. Imagine yourself 5 years from now if you sold that property today. What will it be worth then? What would the incoming rent be? Would you be kicking yourself for getting rid of it when you had the means to hold on? There was a very successful investor here in SoCal who floated a negative cash flowing property for 6 or 7 YEARS before he broke even. I believe we has negative to the tune of about $6,000/year at first! Guess what? 30 years later he made over $1 million from that property's appreciation alone. For the 100th time, cash flow is only ONE of the ways to make money in real estate AND it's probably one of the weakest! The wealthiest real estate investors I know bought good properties in good locations and HELD THEM.

Chris P. · Answer

I've thought of the bandaid analogy myself quite a few times with this property. The $1200/mo is P&I and expenses (tax, ins, repairs). If we ignore the recent depreciation of the property, and assume the tax incentive is a wash, then I question if I'm actually losing money in the long term. Yes, I'm paying out a lot each month in order to pay the loans off but once the property is free and clear (4-5 years) I'll have a good flow of cash coming in off of it. Is my reasoning unsound? Is 4-5 years of negative cash flow inadvisable for the long term? As you can tell, I'm really wrestling with what to do here.. I'd like to keep building out my portfolio over the next 15 years with the goal of about 25 units but I really don't know if this property is going to help achieve that goal.

Owen Dashner · Answer

Chris, My advice would be to dump it- it's a dog. Based on what you described, you have way more negative cashflow than $400/mo. You mention your P&I payment is $1200- what about taxes, insurance, maintenance, repairs, vacancy costs, bookkeeping, etc.? These unaccounted for expenses are taking money out of your pocket every month. Even if you had to sell at a loss, you have to consider how much money you are actually losing every year by owning the property. It's always better to rip off a bandaid than pull it off slowly. :)

Chris P. · Answer

Thanks for the reply, Paul. Yes, I'm equipped to handle the management and repair (including major repair) of the property as it may be needed. My folks have slowly acquired a portfolio of several properties since I was a kid so I've kind of "grown up" with my toes in the business. Their strategy has been to pay the properties off ASAP and so something that concerns me about the REFI is that it will be into a 30 year loan whereas if I keep throwing extra money at the existing loans, the property should be paid off in under 5 years. The property should appreciate over time. It's located in a popular area. But it is an older home which was built in the 1920's and I'm expecting some significant repair in the next 5 years (roof & bathroom renovation). So I guess I'm trying to weigh the benefits of having the property paid off in 5 years but at the cost of extra income and the opportunity cost of my extra cash during that period.