Is this investment strategy crazy or the best ever?

Question

Hello all!Here's the scenario: My boss is now investing in residential real estate. His goal is to own 25 properties by the end of the year. I am not sure how he came up with 25 as his goal, but he currently owns 6 properties. His annual cash flow from these 6 properties is -$14,000 (He paid $122,000 cash for one property by selling some stocks he owns). That's not a typo, his cash flow is negative. He says he doesn't mind the negative cash flow because in years 10-30 the properties will be paid off and his cash flow will be about $45,000/yr on the 6 properties. Now, he is trying to get some of our clients (we work in a different field all together) to use the same investment strategy. Does this make sense? Is this sound? What are the pros and cons, issues, etc with this strategy? Any advice is greatly appreciated and if anyone needs more info I will gladly supply it. Thanks!

Justin R. · Answer

Listen to what Frank Jiang said. It's either that, or a bad strategy. To understand the fundamentals of the investment, you'd have to know what the NOI of the properties is. THAT should be positive or a plan to get positive (or you're just speculating). If you've got cash to burn in the first couple years, there's nothing wrong with shorter term amortization that turns your cash flow negative. For 95%+ of the people on BP, that's not going to be the best strategy for them personally, but who knows what your boss' situation is.

Vincent Crane · Answer

This is awful. By paying cash on one property he's missing out on leverage on multiple properties he can have instead. It sounds like he doesn't know how to analyze a deal. 99% of properties don't cashflow and I don't think he understands how to look through everything on the market to really find the ones worth buying. I'd recommend he spend some time on BP learning about deal analysis and using a BP cashflow calculator to get a big picture of the cashflow and really account for the expenses associated with the purchases. There's no reason to buy a negative cashflow property and speculating on appreciation isn't a wise move. You should aim for around $200/mo in positive cashflow per door. If he has that much money he could've bought a $400k multi that cashflows over $1k per month pretty easily. If there aren't cashflowing deals in the area he lives, maybe he should consider investment in another market altogether. Hope this helps.

Jon Magnusson · Answer

I would run, don't walk away from this! He could've easily found 6 properties that positive cash flow. Plus being in a declining neighborhood. He's setting himself up for failure!

Jesse T. · Answer

Sounds like a strategy to make a small fortune ... assuming he is starting with a large one.If he was buying higher-end properties on short amortizations and counting paper losses from depreciation, he would be speculating - but I could see upside potential.Maybe use a stock/mutual fund example to get through to him. He is essentially buying barely solvent penny stocks in an over-priced mutual fund - I am not sure you can actually find a stock investment that bad.

Frank Jiang · Answer

Option 1: What Tyson said, sell immediately after amortization's over. Option 2: hold for cashflow after. Both assuming that: home values somehow hold up and don't depreciate in the declining area, rent values hold in a declining area, maintenance expenses don't surpass your very new landlord boss's inexperienced forecast. All that risk, loss of liquidity, and finangling for 9 percent?

Tyson Taylor · Answer

I'm having trouble imagining how this will end well. You say he's not doing it for tax reasons and the neighborhood is in decline, well in what other scenario does this work out well in the end?He may be looking at it like @Alexander Felice mentioned. He's got some 10 year loans on ~$450k worth of property. He's put $122K down, borrowed the $328k and is paying $14k a year ($140k all in). So by his math, in 10 years he owns $450k worth of property for $262k out of pocket. That's nearly a 50% return and there's no property value inflation included! Maybe someone could talk themselves into it that way? I can't do the math in my head but it's less than 5% annual return. I don't know, seems like a longshot.Smarter to put your $122k down on a nice little 4-plex that returns at a 7-8% cap. He'll have cash flow and equity for the next deal.

Frank Jiang · Answer

If he has to sell other assets to fund this, he is making a huge mistake. You have to already have a significant amount of wealth and have no worries about financial liquidity to make this sort of strategy work. That's assuming that the underlying deal is good and he's only negative CF because of financing strategy.Imagine this situation: economy goes to hell like 2008, your boss loses his job, loses all his tenants, and has a major capital expense all in the same year. What does he do?

Charles Martini · Answer

The houses he is buying are turnkey in a declining neighborhood. He also isn't doing this for tax reasons. It is a tremendous amount of cash upfront and huge losses every year. I have a hard time making sense of this, but he is adament that he has found a great investing strategy. I am just wondering if I am missing something.Thanks for the replies everyone! This is extremely helpful!

Alexander Felice · Answer

Would you keep investing in stocks that lose money?would you like to own a restaurant that loses money?Would you invest in cars that depreciate, cost money every month and generate no income? NO NO NO This isn't investing, it's speculating AT BEST. in 10 years he might make 45k per year but he already lost 140,000 (plus expenses, inflation, etc)steer very clear of this guy, he isn't investing he's trying to brute force his way into the market. Unfortunately it doesn't really work that way.

Nicholas Crum · Answer

He sounds like a smart man. I would sit him down and ask why he is ok with taking those kind of losses. In REI losses like that is a bad investment. In the long run he is thinking house are free and clear but why wait 30 years for that to happen when you can find a good deal and cash flow immediately?