General Landlording & Rental Properties
Market News & Data
General Info
Real Estate Strategies
Landlording & Rental Properties
Real Estate Professionals
Financial, Tax, & Legal
Real Estate Classifieds
Reviews & Feedback
Updated over 3 years ago, 08/11/2021
Capex wipes out cash flow for a year?
So long question short, my rental property averages about $150 a month cash flow after regular maintenance expenses and minor repairs. But for a capex expense, my next one being a bath tub replacement or replacing the carpet with LVP. Is it normal that a minor $3k expense such as those would wipe out my year's worth of cash flow, and leave me in the red on paper? Justified by the fact it's not a normal yearly expense, Or does my rental just suck? Mortgage PITI is $900, rent is $1300. Mortgage is high as it's year 4 of a 15 year mortgage.
Thanks,
Bill
- Residential Real Estate Investor
- Kansas City, MO
- 4,845
- Votes |
- 10,045
- Posts
Yup, many such cases! Welcome to buy and hold real estate investment. The dirty secret is that while cash flow is nice, it's rather fickle and mostly the "cherry on top." It's appreciation, principal paydown and tax advantages that get you rich over time.
There is good reason to pay off mortgages earlier. It depends on what else you would do with the cash. If the cap rate return on a paid off property is risk adjusted better than what you would do elsewhere then nothing wrong in parking your capital in home equity. For example a 1%/50% rule home generates 6% cap rate. Risk adjusted that's not so bad for a predictable income stream. A fixed annuity might give similar but you are drawing down your capital. In the case of the house it keeps and grows equity. For retired people paid of mortgages absolutely makes sense.
In the case of the OP if the 1300 rent generates 650 in actual cash flow after 50% expenses then his cap rate is about 4.5% after the mortgage is paid off. His risk is reduced as he has no mortgage payment. And rents will grow over time as will his equity. If he doesn't want to grow his portfolio anymore that is the correct end game.
@Colin Gearity I moved out in June 2018, so I think I just missed that window. Current lease is through December.
@Dan H. yes, I do invest about 25% of my income in my 457 plan through work already and it's been doing great. I know there's more possibilities on higher return rates. The interest rate is 3% on that loan. I don't have the connections, the experience, or the desire, to take the money out for a flip or BRRR. Although I do understand the concepts. I'm content with my one property, and lack of effort it takes.
The only possible addition would be if I moved again and made my current residence a second rental, it would would rent for 1700-1800, mortgage piti is $1000. The current rental is sustaining itself is like a nest egg that I can't blow the money on. I have looked at selling and investing the money and play with those numbers often. I'm not a savvy investor and I'm OK with that, which is why I'm not going chasing every last penny with the house money. It's kinda like a side hobby. I already work 60 hrs. a week I don't need another job.
I appreciate everyone's input, thank you guys.
Wait until you have to replace a roof or HVAC system. Not accounting for this type of expense is common. People think their "cash flow" is going to be the difference between the rent and PITI. Then in a few years they don't understand why they have never made money in real estate and sell their properties. You have to buy knowing there are going to be expenses like this, and get deals that will cash flow despite them.
@Eric James Yes I know the price on those, I replaced both in the last 5 years so they should be good for awhile. That was one reason I was willing to rent the house, almost everything high dollar had already been replaced.
My perspective on this is a little different from a lot of the replies here. For example, I have a single family house I bought about 20 years ago with a 15 year mortgage for about 85,000. It lost, cash flow wise, about $500 to $800 dollars a year for 15 years. It is currently paid off and the rents are $1200 per month.
@Bill Ward - This is why I'm selling my smaller buildings for larger multi-family. These smaller buildings just suck up your cash with repairs, cap ex and turnover. There's not enough opportunities to make money on them (additional doors/rent)
Originally posted by @Doug Garrison:
My perspective on this is a little different from a lot of the replies here. For example, I have a single family house I bought about 20 years ago with a 15 year mortgage for about 85,000. It lost, cash flow wise, about $500 to $800 dollars a year for 15 years. It is currently paid off and the rents are $1200 per month.
Problems with that are:
-you can't do that 50 times over because the negative cash flow will drain you.
-there are properties that DO cash flow after expenses, so no reason to buy those that don't. Unless maybe someone is expecting huge appreciation.
@Bill Ward yeah those numbers looks like it’s cutting it kind of close. I kind of understand if it was a fairly new house with some expected appreciation.
I love what Joe said. That is exactly what I teach my clients. Never do cap ex with current cash flow. Recipe for disaster. Also, like it was also mentioned above, don't look at a roof replacement as killing your cash flow. There are accounting benefits to the expense of the new roof that you are not taking into consideration when you say that your cash flow is non existent. Apples and oranges.
You should run the analysis for cash flow factoring in cap/ex/reserves/average big costs like a new roof, etc. Feel free to PM me if want rough breakdown how to use for next buy. For now maybe refinance into a 30 year to cut mortgage payment and increase cashflow.
Bill, my two cents, I had limited cash flow on mine at the beginning, too. Now rates are low and leverage is attractive -- BUT my whole portfolio is 100% paid off except for one 15 year mortgage which pays off this November. (This is where almost everyone will chime in and say I am an idiot :) !) I stopped working 5 years into RE investing; around age 45. I did some flips and paid off everything with the profits over the last few (nonworking) years. I am debating putting financing on some places just to diversify and enhance investment income, but honestly life is easy and stress free with no debt, and my income is greater than my expenses already. It comes down to more toys, more luxuries .. and I do okay in those areas already :)
I am currently paying cash to invest in $30,000 in upgrades that will wipe out all of my net cash flow for this year and part of next year on a 3 unit building. However, it will raise rent by as much as $450/month, and raise the value of the property by as much as $50,000 -- and reduce my worries on having ugly old kitchens and baths, make it easier to rent, and easier to maintain, AND easier to sell. And I see the cost to do these same renovations as being higher next year, plus I have the cash -- so why not? I could defer these expenses and rent my dated property because demand is high. I could finance the improvements (I have an LOC I could use; I could do a complete refi or this or any or all the properties). I just prefer not to...so far.
So, I think you are fine based on your own goals. I also think selling and taking the profit in this hot market isn't a bad idea (as you said, your profit is way up after 3 years of renting) -- and you will likely need to make your capital improvement to get top dollar on the exit.
It all comes down to having a business and life plan that works for YOU (which can be flexible), and executing. My plan was first, to make enough to quit working (done.) Then, to reach specific net worth goals, and income goals, by specific ages. I originally planned to cash flow my kids through college -- now their tuition is sitting in a 529, fully funded. I planned to live off rentals for life in retirement; now I may liquidate the portfolio prior to collecting SSI -- but that is a decade away, and tax laws and economic conditions are constantly changing. So, I remain armed with a plan, and flexible enough to adapt!
I will just say that paying off debt aggressively was hard at first -- but is making life very, very easy now! I recognize that greater risk delivers greater rewards; I risked quite alot when I got started in RE; I am enjoying a low risk, low stress lifestyle now.
#4 All Forums Contributor
- Plymouth, MI
Originally posted by @Doug Garrison:
My perspective on this is a little different from a lot of the replies here. For example, I have a single family house I bought about 20 years ago with a 15 year mortgage for about 85,000. It lost, cash flow wise, about $500 to $800 dollars a year for 15 years. It is currently paid off and the rents are $1200 per month.
So, let's add this up.$650 (we'll take your average CF loss/yr) x 15 years = $9750. You paid it off, and have had the home for an additional 5 years with positive CF. Assuming the interest rate of 6% over the life of your loan, and the $85k loan, the monthly payments would be around $700/month...which, added to your $650/year loss (~$50/m) is now your cash flow = $700/month ($8400/year).
So, that means over a 20 year period, your cash profit is $42k, or $2100/yr. So you're happy with that?
Let me add, that when you have negative CF, that negative amount has to be paid by you from another source, which means you are losing money there too. How does that translate in real life? If you got that $650/month from your personal funds, it means whatever bill that money was paying, has to be paid by other means...usually savings,...
...or another cash flowing property. That's like saying your job pays you enough money that you are willing to take on a second job, and pay that employer for the privilege of working there.
"at this point I care so little about cash flow - None of my properties on their best month of cash flow has achieved their average monthly appreciation over my hold period"
@Dan H. That's crazy. That goes to show how ridiculous real estate prices are in 2021. Maybe the OP should sell! That's the easy thing to do... cash-flow? 30yr Refi? forget all that jazz.
@Bill Ward you are not cash flowing $150 per month. Your cash flow is negative because you did not properly account for CapEx expenses.
- Matthew Irish-Jones
Originally posted by @Jaron Walling:
"at this point I care so little about cash flow - None of my properties on their best month of cash flow has achieved their average monthly appreciation over my hold period"
@Dan H. That's crazy. That goes to show how ridiculous real estate prices are in 2021. Maybe the OP should sell! That's the easy thing to do... cash-flow? 30yr Refi? forget all that jazz.
It is crazy!
Like most investors with multiple properties some have been purchased with good timing and some with not so good timing. My worst appreciating property per month of hold depreciated over 15% in the next few years after purchase. Its appreciation now, over the hold period, is $1.9K/month. That is a poorly timed purchase (I had a similarly poorly timed purchase that depreciated close to 20% after purchase but its appreciation is ~$2.7k/month) that is my worst appreciation RE per month of hold. It is a SFH and it has never had cash flow at $1.9K/month. I suspect before the last refi is was approaching $1K/month of cashflow (I include everything in my expense estimates even a misc that includes items like its share of LLC costs, its share of umbrella coverage, a utilities estimate for the rare occurrence when the utilities should be paid by LL such as a slab leak, etc.). After the last refi (NYE), it is showing ~$275/month of cash flow with my expense estimates.
Our best appreciating property has appreciated ~$6.7K/month over its 21 year hold (you can do the math if you would like). It was a well timed purchase in a great location (it is in a prime STR location but we purchased it before STRs were popular - before AirBNB or VRBO existed). Our value add was to make it an STR. Today converting to STR is so mundane that the STR potential is built into the selling price and therefore typically it cannot be a value add (I do leave room for places such as a casino is opening in 6 months and the sellers have not yet factored the resulting STR potential into the price as an exception).
BTW 2021 and its over 20% RE appreciation has helped these numbers, but they were already outstanding. The RE that is currently at $1.9k/month was already over $1.7K month. If you read some posts of mine from fairly recent you will see that worse property listed as $1.7/month of appreciation (some was that I had not calculated the number in a while and some was the improvement of the number from the recent price increase).
It is crazy! To be blunt, I thought in the early 1990s RE prices were so high they could not go much higher. Except for 2010 to 2015 I have maintained this belief and yet the RE prices continue to rise.
Good luck
Originally posted by @Matthew Irish-Jones:
@Bill Ward you are not cash flowing $150 per month. Your cash flow is negative because you did not properly account for CapEx expenses.
That's quite probably true, I don't have the numbers in front of me. That's why I'm on here daily and never decide whether to refinance, sell, or ride it out as is.
@Bill Ward totally understand and I have made more mistakes than pretty much anyone I know so I feel your pain.
For future reference I would suggest getting a hard number for your CapEx. For example:
1. Roof needs to be replaced in 10 years $25,000
2. 2 furnaces = $7000
3. Apartment turnover = $10,000
4. 2 Hot water tanks = $2400
Total = $44,400/10 years = $4440 in Cap Ex expenses for year. This is an easy way to understand and project out CapEx expenses. You really don't want to use a rent roll % because it can be skewed on a lower rent roll.
Maintenance and CapEx are your most variable expenses and they become difficult to project when you work off of a %. Using hard line items and dividing by time gives a more accurate figure in my opinion.
None of this means you have a bad deal on your hand. There are A class assets in highly appreciating markets that barely cash flow. I don't know the rest of the specifics on your property so its hard to say if its worth keeping or selling.
Cash flow is important but, it is not the only line item that matters. Asset condition and location are as important if not more important.
Hang in there Bro, we have all been there. Best advice I ever got is sometimes you win, and sometimes you learn. I have paid a lot of learning fee's in my time!
- Matthew Irish-Jones
I would say a 15 is bad if you are paying any points or fees on it. I'm getting 25 year am loans at 3.5% (5yr lock) with 20% down. If its 1-4 units they don't even run an appraisal. (commercial loans) As far as capx it happens you either need cash to pay it or a line of credit to draw to do it (and the cf to pay the line off).
That you are talking about spending excess $ on toys gives a clue -- the total profit is the important thing. You are not invested for your current age self, you are investing for your future, retired self. Your hit by a car, can't work, don't WANT to work self could move back into this house in 15 years and be living pretty well.
Here's how I handle my investments (for my future 70-year-old self);
ALL the $ goes into a separate account (at a separate bank). Keeps me honest about how much I am (am not) making. Spoiler alert -- you don't make as much as you think you do, and not nearly as much as your tenants think you do LOL. This set-up also makes taxes MUCH easier -- all the expenses from that account minus principle pay-down = profit. Remember to take depreciation -- this is sort of the icing on the cake, and even on years I don't net a dime in the house account, I save some $ on my taxes (not offering tax advice!) BTW, the IRS will pretend you took it when you sell (and charge depreciation recapture taxes), so you might as well take it. If I put my personal money into the "rental" account that is easily accounted for (trust me -- your tax person will SOOO love you for this). Then just let it ride. Your rent goes in, your monthly expenses and Capex come out. Your mortgage trundles on, your loan principle gets paid off. At the end of 15 years you own a house.
In your particular case, since this is investment in your future it may not matter if it's a 15year or 30. I'm a big fan of taking the 30, but PAY as if it's 15. At this point it's probably not worth doing a refi -- cost of loan and higher rates on rental property would probably wipe out any benefit. If you need access to the equity do a HELOC.
@Bill Ward multi-family property will solve this by economies of scale
Thanks @Deanna O. It appears I haven't factored in capex expenses into my monthly cash flow yet. I do keep a log of all expenses and cash in so I can see my actual cash flow. I don't need access now for the equity and don't plan to as I don't plan to buy any other properties at this point. It is just a nest egg for my future self. I appreciate all the responses. You have all helped me.
Your math is all wrong.
My total cash losses per year were about 650 so about 9750 total. I of course included principle and interest payments in my cash flow numbers. I put down 10000 of my own money. So I invested, out of pocket a total of 19,750 My current cash flow is approximately 7 to 8000 per year after all expenses. Plus I have a house that I could easily sell as is for 165000.
Absolutely
My goal with my rental property was to build up an income stream in my retirement with rental property as an alternative to a 401K since I was self employed. If I had invested the entire 19,750 in some other investment 20 years ago at 11% returns per year (not very likely) I would now have 143,000. I do still believe that this house was a good investment.
If you add the current value of 165,000 to the 42,000 you have a total return of 207,000 on a 20,000 investment.
#4 All Forums Contributor
- Plymouth, MI
Originally posted by @Doug Garrison:
Your math is all wrong.
My total cash losses per year were about 650 so about 9750 total. I of course included principle and interest payments in my cash flow numbers. I put down 10000 of my own money. So I invested, out of pocket a total of 19,750 My current cash flow is approximately 7 to 8000 per year after all expenses. Plus I have a house that I could easily sell as is for 165000.
Absolutely
My goal with my rental property was to build up an income stream in my retirement with rental property as an alternative to a 401K since I was self employed. If I had invested the entire 19,750 in some other investment 20 years ago at 11% returns per year (not very likely) I would now have 143,000. I do still believe that this house was a good investment.
If you add the current value of 165,000 to the 42,000 you have a total return of 207,000 on a 20,000 investment.
The equity build up you are talking about isn't profit to you...yet, it's the property's profit. It's a trophy for buying a good property, but you can't do anything with it, so it has no real value...yet (again). The value of your equity only turns real when it is converted to cash...which means you sell it, which may or may not be equal to the face value of that equity. You're going to lose big parts of that value from all closing costs/fees plus all the taxes (can you say"capital gains"). The tax/financial rules you're counting on today may not be in play when this time comes. Just look at the bills in congress today.
Now, let's look at the real loss here...the relationship between the cash (CF and equity) value and the true value of that cash, as in what that cash buys you today. Let me say this, I group equity into the cash column in the sense that it is frozen cash, as opposed to liquid cash (CF). Both examples of cash is what your cost is for the property because both give you the ability to buy value.
Here's the problem, When you spend cash as a DP (let's say 20% for example) that buys you 5 times the face value of that cash. When the equity increases, it does so on a 1 to 1 relationship with property value (appreciation). This added equity, although it increases the total equity, is reducing the true value of the total equity.
Now, if the property is sold, and the solid cash is converted to liquid cash, and used to buy the next investment(s) as a 20% DP, all of it now has a true value of 5 times its face value. The total equity doesn't change, but if you were to buy two properties just like the first one, your CF should also double. If this is repeated whenever the total equity doubles the initial DP, you have a compounding effect on your returns for both PV and CF.
This doesn't change your desired goal of the CF replacing your 401k income upon retirement. It enhances it...much faster.