Need some advice, Negative cash flow EVER a good idea?

Question

Evening all,

Im at what i think is a huge decision point and need a little help.  Just some quick background...  Im a Young military invest with three properties under my belt and a strong appetite for risk.

My Investor minded realtor always sends me deals and he recently sent me a listing for a 10 property portfolio of SFHs for about 450k.  The owner is willing to owner finance @ 4% amoritized over 10 years (the terms are flexible)  I cant qualify for traditional financing on this deal simply b/c my D/I wont allow for it.  At the end of the day i'd probably be in the red about 100/month after being VERY conservative on PITI, and 10% each for property management, maintenance, and vacancy.

My income can handle much more than 100/month in the red on this and my rationale is that after "investing" 100/month over 10 years i would have a 500k (conservative estimate) portfolio i only paid 12k for.  I also understand that i could shop for a refinance on this portfolio at some point in the future and possibly get different terms if i need them.

There are a few variables, of course.  If these properties are deeded independently then i assume that the closing costs will be very expensive.  If, somehow they are deeded as a portfolio then i wouldn't have the easy ability to sell, say 5 of them, in the future if i want to.

I will post more detailed numbers once i complete the property analysis spreadsheets i've dowloaded from the BP thread on the subject.

Thanks,

Logan

Matthew Paul · Answer

The real question is ... Why is he selling?     I would scope out the neighborhood , talk to the tenants , and talk to some neighbors before I jump .

Kenneth Hynes · Answer

@Troy Brown any update on tis..  certainly an intersting proposition.  i ran the loan numbers and it looks like the (~438K for 10 years at 4%) look like $4500 a month, but 3 K of that is equity buildup.

Ben Skove · Answer

One other thing to think about is, given that all the properties are on one street, is that all of your eggs are in one basket. This can be a double-edged sword, in that you can use those factors which are in your control to improve values in the area; however, factors outside of your control can also affect your portfolio as a whole in a negative way. Just something to chew on!

Account Closed · Answer

I'm the one who is conservative.  I say the expenses and vacancy over the long haul is 50%, not including property management.  But I know mostly lower end rentals (under $75K in CA), as that's who my repeat buyers are and where I get the info.  My longest hold was 3 years.  The $6K main line break on that one definitely needed an additional 7 years to make it average out to as low as 50%. :)

Forrest B. · Answer

Troy,

I'm in the military as well, and have a rental (bought as primary about 12 years ago) in Norfolk.  Since we bought as our primary residence, the income doesn't meet the 2% rule, nor the 50% rule.

In fact, I refinanced the principal mortgage to a 20 year just to realize extra equity in the case I sell it in 3-5 years--cash flow isn't the priority for me here.  If I don't sell, it'll get paid off faster.  The tradeoff is ~$250 per month, which I could attribute to 'forced savings,' similar to what you're discussing with the $100 per month out of pocket.

So ask yourself, "what if?"  What if that loan balance was amortized over 30 years?  The difference between that 30-year PITI and your proposed PITI would be your 'forced savings.'  The 50% rule would look a lot different because your loan is amortized over 20 more years.

With that said, your 'forced savings' isn't the only key factor here.  That should only serve to help you frame your comfort level...if you'd rather put $100, $200, or $500 away towards this portfolio instead of an IRA or TSP, that makes sense.

However, you definitely need to do the research & make sure your numbers are solid, and that you've got cash reserves (or access to a line of credit) to tap into.  Know the properties up front, major repairs/replacements that need to be made, warranties on recent repairs/replacements, expenses, leases (are they all ending within a month or two of each other--what happens if you have two or three vacancies at a time).

With seller financing, you should be able to negotiate your first year (or two) of payments based upon rental income after expenses.  If the properties are solid, the seller should be willing to give this to you, knowing their rents & expenses are in line.  If not, I'd be very skeptical & see what potential problems you're about to take over (deferred maintenance, lease expiration, evictions, etc.).  Don't underestimate your expenses just because you're okay with putting some money out of pocket on the PITI side.

Assuming the deal works, after you've established a record of payments, you should be able to refinance at least some (if not all) of the properties to get your PITI down.

Hope this helps.
Forrest

Troy Brown · Answer

@K. Marie Poe You make some great points.  I am being conservative on the Taxes and Insurance because i havent received a quote on what it would cost to insure them.  I know USAA wont cover them b/c its a coastal area and i already have too many properties in that area for them to accept the risk....so i have to shop around for it.

Also, I meant to say 10% per expense for those three costs so a total of 30% but i know a rule of thumb here on the forum is take 50% off the top so ill take a look from that perspective.

@Matthew Paul I agree, im always interested in motivations although it can be very hard to ferret out.  Talking to the tenants is always a great idea and i will certainly try to get someone to do it for me, unfortunately the military has me several states away from the properties.

Account Closed · Answer

I missed this on the first read.  PITI is PITI.  Starting out, those are known numbers, not guesses, so conservative doesn't mean much.  10% each for PM, maintenance and vacancy is off IMO.  One repaint and recarpet on a vacancy will put you over that, not including the missed rent.  And doesn't include a roof or plumber or hvac costs you'll have on ten properties in ten years.  The real costs are closer to 40-50% in lower income props over the long haul.  Ask anyone who has had properties for more than a few years and really crunches the numbers.

Account Closed · Answer

The seller financing loan for the 10 properties doesn't necessarily count against your ability to borrow for other properties.  Depending on how the properties are producing when you refi, you maybe able to get a commercial loan.

I suggest that you don't let the seller financing get in the way of how you would analyze the other factors in the deal.  Since you know you have a property management challenge, factor the cost of that in and see what number you really need to buy for to make it cash flow neutral.

Account Closed · Answer

Doesn't matter if you buy and/or borrow them as a portfolio.  As long as they are separate parcels and don't have something weird like shared driveways, etc, they can be sold separately at any time.

Seller financing doesn't always represent a seller looking for income, but rather can indicate something difficult or impossible to finance. 4% is low for investor borrowing, so that's another red flag (to me) that the seller might be trying to create selling options where none exist.

Neutral or slightly negative cash flow isn't always a bad idea.  But what about values?  Will you be able to refinance them?  What are they are really worth?

Troy Brown · Answer

I will be putting down 10% now and financing the remainder through owner financing at 4%.  As the deal currently stands the option to cherry pick the best 4-5 doesnt exist, although i havnt actually put in an offer to that effect.

Need some advice, Negative cash flow EVER a good idea?

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