Is Negative Cash on Cash ROI considered a good investment ?

General Landlording & Rental Properties
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Is Negative Cash on Cash ROI considered a good investment ?

Ahmed Elias
Edison, NJ · Member since 2018 · 46 posts · 12 votes

Hi BP Community 

I am a newbie investor and trying to invest in the Mid West with the hope to generate positive cash flow. Since this is my first investment I am trying to play it a little safe. My concern is that I am getting a negative Cash on Cash ROI when estimating 20% down. I also think that I maybe a little too conservative with my numbers - Below is what I have so far and I was hoping if I someone could guide me in the right direction - This is a house in the Greater Indianapolis Area. Also please do let me know if there is anything I am missing. Thanks in advance :) 

Asking Price: 170,000

  
Unity Type Square feet Rent Monthly Yearly
1 3bed/1bath $ 1,300.00 $ 1,300.00 $ 15,600.00
Monthly  Yearly
Gross Rental Income $ 1,300.00 $ 15,600.00
Other Income
Vaccancy loss $ 109.20 $ 1,310.40
Total Operating Income $ 1,190.80 $ 14,289.60
Expenses


Insurance (Hazard) Normal $ 70.83 $ 850.00
Landscape Maintenance $ 33.80 $ 405.60
Maintenance Handyman $ 65.00 $ 780.00
Manager Salary/Management fee $ 130.00 $ 1,560.00
Miscellaneous Expenses $ 26.00 $ 312.00
Reserves $ 80.50 $ 966.00
Supplies (maintenance) $ 26.00 $ 312.00
Taxes (Property) $ 198.33 $ 2,380.00



Total Operating Expenses $ 630.47 $ 7,565.60
% of Operating Expenses to Income 53%
Net Operating Income $ 560.33 $ 6,724.00
Financing
Purchase Price $ 170,000.00
Down Payment 20% $ 34,000.00
Loan Amount $ 136,000.00
Interest Rate 5.0%
Term of Loan 30
Settlement Fees
Origination fee (Title, Title Insurance and Deed Processing Fee) $ 1,632.00
Discount fee
Closing Costs and Misc Fees
$ 680.00
Total Cash Outlay $ 36,312.00
The Loan
Monthly Loan Payment (Principlal + Interest) $ 730.00
Monthly Payment (PITI) $ 999.24
Investment Analysis - Settlement fees paid by buyer which is me
Cash Outlay (Down Payment + Settlement Fees) $ 36,312.00


Total Operating Income $ 1,190.80 $ 14,289.60
Less: Total Operating Expenses $ 630.47 $ 7,565.60
Net Operating Income $ 560.33 $ 6,724.00
Less: Monthly Loan Payment (Principal & Interest) $ 730.00 $ 8,760.00
Cash Flow (Monthly Loan Payment - Net operating income                                                                                                                    $ (169.67) $(2,036.00)  
Cash on Cash ROI (Cash flow/Total Cash Outlay) -5.6070%
Investment Analysis - Settlement Fees added into loan amount
Cash Outlay (Down Payment + Settlement/Closing Fees)  $ 36,312.00
Monthly Yearly
Total Operating Income $ 1,190.80 $ 14,289.60
Less: Total Operating Expenses $ 630.47 $ 7,565.60
Net Operating Income $ 560.33 $ 6,724.00
Less: Loan Payment (Principal & Interest) $ 742.41 $ 8,908.92
Cash Flow $ (182.08) $ (2,184.92)
Cash on Cash ROI (Cash flow/Total Cash Outlay) -6.0171%
Cap Rate (NOI/Purchase Price) 3.9553%
   
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Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
8y

Multiple choice Question:  Why would you buy a rental property, with negative cash flow?

Answers:  

A - To help the tenant pay for their rental expenses
B - To have to find a different source of income (investment) to cover the negative income on this property...but you have no money now, or in the foreseeable future, to invest with.
C - To rationalize that the property will be gaining in appreciation faster than you are losing cash per year.
D - To put yourself in a "cash poor" situation, and making that situation worse by the month.
E - To put yourself in a position where if you are in need of cash, you can always borrow the money, and as a result of the negative cash flow, need an added source of income to pay off that new debt.
F - All of the above.

4Reply
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  • Ahmed Elias
    OP
    Edison, NJ · Member since 2018 · 46 posts · 12 votes
    8y

    Also i I just realized this is a pretty long post. So really sorry about that. 

    0Reply
  • Joe Hines
    Investor · San Jose, CA · Member since 2017 · 118 posts · 108 votes
    8y

    Hi Ahmed,

    Glancing over your numbers, none of the costs jumped out at me as wildly out of line. There is a problem with the last line where you calculate Cap Rate. With a negative NOI, there should be no way to get a positive Cap Rate.

    That aside, however, there is one key fact would cause me to reject this deal out-of-hand:  For a $170K property, I would need at least $1,700 per month in rent and even more if I was looking to carry a mortgage on it.  This handy rule is called the 1% Rule (also known as the 2% rule in more favorable real estate markets) and it means that you should always seek to get 1% of the purchase cost + initial repair costs + other acquisition costs each month in rent.

    This property is looking to give a negative cash flow and therefore negative Cash-on-Cash ROI, so this isn't a feasible deal. In my opinion, the initial cost is just too high.

    2Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    8y
    Didn’t read the post or the numbers because the formatting is pretty awful. Negative cash flow is bad and so is negative ROI
    1Reply
  • Joe VilleneuvePro Member
    Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
    8y

    Multiple choice Question:  Why would you buy a rental property, with negative cash flow?

    Answers:  

    A - To help the tenant pay for their rental expenses
    B - To have to find a different source of income (investment) to cover the negative income on this property...but you have no money now, or in the foreseeable future, to invest with.
    C - To rationalize that the property will be gaining in appreciation faster than you are losing cash per year.
    D - To put yourself in a "cash poor" situation, and making that situation worse by the month.
    E - To put yourself in a position where if you are in need of cash, you can always borrow the money, and as a result of the negative cash flow, need an added source of income to pay off that new debt.
    F - All of the above.

    4Reply
  • Dean Letfus
    Specialist · Memphis, TN · Member since 2012 · 1k+ posts · 1k+ votes
    8y

    @Ahmed Elias, I think the answer to your specific situation is yes, negative cashflow is bad. The only time it is good theoretically is when there is a compelling case for gain in another way. For example I occasionally buy some homes in A grade areas using seller financing that are slightly negative cashflow. However the capital appreciation on the properties is very high so I fund them for 3 to 5years then sell, banking my profit from the growth.  

    But in the USA especially there is rarely a good reason to build a negatively geared portfolio.

    0Reply
  • Dick Stevens
    Rental Property Investor · Haverhill, MA · Member since 2017 · 290 posts · 185 votes
    8y

    If you need to ask if negative ROI is bad, I don't think you should go into business.

    3Reply
  • Ahmed Elias
    OP
    Edison, NJ · Member since 2018 · 46 posts · 12 votes
    8y

    @Joe Hines Thank you so much for looking at the numbers and really sorry for the awful format. Based on my initial post I just wanted to make sure we were looking at the same numbers, my NOI shows me $6724.00 annually. I just wanted to make sure you saw that and not a different number. That being said

    NOI at $6724

    Purchase Price - $170,000

    Cap Rate would be 3.9553% which is NOI divided by the actual Purchase price right ?

    I just want to make sure that I am actually doing this right lol. 

    I really like the 1% and 2% rule tip that you suggested and I am hoping I find deal of that nature. 

    Thanks 

    0Reply
  • Ahmed Elias
    OP
    Edison, NJ · Member since 2018 · 46 posts · 12 votes
    8y

    @Caleb Heimsoth sorry for the Awful format - I am hoping now it would be a little better. Would love to know your thoughts - Thanks :) 

    Asking Price - $170,000

    Annual Income - $15,600

    Vacancy - $1310

    Total Operating Income - $14, 289

    Total Operating Expenses (Maintenance, Mgt Fee, Reserves, Taxes, Misc) - $7565.00

    Net Operating Income - (14,289 - 7565) = $6724

    I am going Conventional with 20% down - 

    Down Payment = $34,000

    Interest Rate at 5% 

    Loan Term = 30 yrs 

    Closing Fees =  $2312.00 

    Monthly Payment (PI) = $730.00  = Annually = $8760

    Monthly Payment (PITI) = $999.24 = Annually = $11,990.88

    Total Cash Outlay (Down Payment + Closing Fees) = $36,312 

    Cash Flow (Monthly Loan Payment - NOI) = $(2036)

    Cash on Cash ROI (Cash Flow/Total Cash Flow) = -6.0171%

    Cap Rate =   $6724/$170,000 = 3.9553%

    0Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    8y

    @Ahmed Elias this doesn’t meet the 1 percent rule which is the bare minimum for me (should be higher), so I’d pass on this all day long.

    0Reply
  • Ahmed Elias
    OP
    Edison, NJ · Member since 2018 · 46 posts · 12 votes
    8y

    @Dean Letfus Thanks for the insight. I think I knew negative cashflow was not a good idea but I also wanted assurance from other experienced investors. Also I wanted to make sure if my estimations were not too crazy conservative. Appreciate your advice. 

    0Reply
  • Ahmed Elias
    OP
    Edison, NJ · Member since 2018 · 46 posts · 12 votes
    8y

    @Caleb Heimsoth - Thanks for the insight. Do you know any good turnkey companies in the Indiana or KS area ? 

    0Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    8y

    @Ahmed Elias I do not.  Good luck 

    0Reply
  • Priceton Braswell
    Hudson, NC · Member since 2016 · 17 posts · 5 votes
    8y
    To Do Get long level for foundation inspection. Find a good structural engineer for foundation Run your life like a successful business while you run a successfull business Llc study Open self directed ira Title search website from Bobby Print nc and local landlord laws Print letter of intent on landlord website Find pro forma to analyze Set up automatic real estate alerts Appointment with banker Invest 5k in crowdfunding Download repair cost from flip book link Trade forex try it out P2P Lending with lending club Invest 100 in upstart Post Craigslist ad of apartment for rent Cancel Hulu Make LinkedIn account Property licensing Bylaw infraction Outstanding work orders Take the piti part away. Your taxes and insurance should already be calculated in your expenses above to get your NOI. So here’s the deal, your NOI is 6724. That’s what your property is making before the mortgage payment. Since your paying so much for the property your mortgage payments per year are 8760 annually. You’ve already wrote this down because your smart and very close to figuring this out. Heres were you messed up. Your cash flow formula. The way you get cashflow is by taking that 6724 that the property makes every year and subtracting the mortgage your goina pay for that whole year. 6724 NOI minus 8760 annual mortgage equals -2,036. Ouch!!! What this means is that you will lose 2036 dollars a year running the property and paying the mortgage. So now what you need to do is figure out what you should offer on the property to where your mortgage drops low enough to we’re you are actually making some money.
    1Reply
  • Priceton Braswell
    Hudson, NC · Member since 2016 · 17 posts · 5 votes
    8y
    Sorry for the accidental to do list lol
    0Reply
  • Joe Hines
    Investor · San Jose, CA · Member since 2017 · 118 posts · 108 votes
    8y

    @Ahmed Elias

    Technically, that is correct and this is one of the reasons you have to look at several key measures to ensure the deal is solid.  In this particular question, the problem is that Cap Rate does not take into account the mortgage (P+I).  This is one of the key weaknesses of focusing on Cap Rate.  If you are paying all cash, then Cap Rate is not distorted and it becomes a more solid measure, in my opinion.

    In addition to Cap Rate, I look at Cash Flow and the big daddy of all, Cash-on-Cash Return.  I noticed you have these in your analysis, so when you take all of these measures into account, it becomes clear this isn't a great deal.  

    BTW, the other key measure I pay attention to is where the market is at for a similar home.  I'm a little sensitive to over investment in a property as well.  I've learned that lesson the hard way, primarily by underestimating the cost of renovations.   

    0Reply
  • Peter Antipatis
    Member since 2018 · 25 posts · 20 votes
    8y

    Have to be honest, I clicked because I thought this might be a good joke or funny story from the title, until I saw the effort he took to type out all that info in the first post.  Here are some scenarios under which this is a good deal:

    1. This is not in the midwest, but actually an off-market deal in San Francisco that will be worth 1.7 million by year's end.

    2. He knows for a fact that he can raise rents to $2,000 rather quickly.

    3. $170,000 was merely the asking price, but he felt confident he could get it for $100,000

    4. He's 1031 exchanging into this and only has 1 minute left to identify a property that will save him 30k in taxes.

    No this is not a good deal, seriously, would you invest in a bond that paid negative interest?  Sorry to sound harsh but I suggest spending a lot more time scouring the forums and watching a bunch of podcasts and webinars.  Good luck!

    0Reply
  • Ahmed Elias
    OP
    Edison, NJ · Member since 2018 · 46 posts · 12 votes
    8y

    @Priceton Braswell Thank you so much for breaking things down in a more simplistic manner and I really like your approach on offering a lower price that will for sure make this property a positive cash flow. 

    @Joe 

    @Joe Hines - I am so glad I put these numbers in front of the BP community. As a newbie in the RE game, I was under the impression that Cap Rate is the most important one of them all because thats what most Turnkey Company websites display on their listings. However since Cash Flow is my key priority your analysis makes total sense. 

    @Peter Antipatis I am glad you came into this thread and decided to share your thoughts. Honestly I rather ask the community versus assume because I think thats the best way to learn and get the most realistic answers to a real problem. Thank you so much for your insights, it gave me a lot of good ideas :) 

    0Reply
  • Peter Antipatis
    Member since 2018 · 25 posts · 20 votes
    8y

    Ahmed,

    Although my post was kind of tongue in cheek, here is what you can take away from it.  

    1.  Asking price is almost immaterial as it pertains to you and purchasing an investment.  It is of course relevant to the seller, but that's not your concern.  Evaluate an investment based on your own criteria and make offers that make sense to you.  

    2.  Current rental rates may be maxed out, or might be severely under-market or anywhere in between.  That is up to you to figure out so that you can make competitive offers accordingly.

    3.  Nobody can make the appreciation vs. cash flow decision for you, but it is great to read the argument on both sides and see which one you feel best suits you and that you want to go for.  It sounds like you are interested in cash-flow, which is appropriate given the location, so make sure you are meeting your criteria.

    Just because this property might not be a good deal based on asking price, that does not stop you from offering whatever you want.  There is no penalty or fine for making an offer that makes sense to YOU, and 1 in 100 times you get a pleasant surprise.  Best of luck!

    0Reply
  • Ahmed Elias
    OP
    Edison, NJ · Member since 2018 · 46 posts · 12 votes
    8y

    @Peter Antipatis Thanks for diving into more details. I think you made some really good points. I am assuming its best to put multiple offers on multiple properties looking at numbers that make sense for me right ? 

    0Reply
  • Peter Antipatis
    Member since 2018 · 25 posts · 20 votes
    8y

    Absolutely.  Assuming you've identified a target area, find all the properties you would like to own that are for sale, ignore the asking price, run the numbers on them (you seem to have a good grasp on doing the underwriting) adjust the purchase price until your returns are in line with your needs, and that is the price you want to pay / offer.

    Now compare that number to the seller's asking price, and if it is ridiculously far off, maybe keep that property on your radar and check it often for price drops.  If it is remotely close, make the offer.  Find an agent who is investor friendly and doesn't mind putting in multiple offers for you, it doesn't take long, doesn't cost anything, and if that agent thinks you might be the guy who buys 20 homes through him/her in the next 10 years they should be happy to be part of your team.

    0Reply
  • Mike D'ArrigoPro Member
    Turn key provider · San Jose, CA · Member since 2010 · 4k+ posts · 3k+ votes
    8y

    @Ahmed Elias Under what circumstances would buying a rental property with negative cash flow make any sense? There is nothing about this deal that would attract me. Indianapolis is a strong cash flow market with strong rent to price ratios. This deal has neither. A typical rent to price ratio is around 1%. This one is at only .7%. Aside from the numbers which are a deal breaker right out the shoots, the bed/bath count don't work for a property in that price range and rent. 3/1's are typically found in lower end C class neighborhoods with rents in the $750-$800 range. Unless there is something very unique about the neighborhood, I think you would have a hard time getting $1,300 rent on a 1 bath home. For that kind of rent, most people are going to be looking for at least 2 baths. This one is a non starter in my opinion.

    1Reply
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