Is operating with negative cash flow a good move?

[Kelvin He]

Hello, this post is an update to my previous post : 

To summarize that post: buying a house for ~$250k w/ a 30-yr fixed rate loan, will try to lease it out for ~$2k a month, monthly expenses are ~2.2k a month.

The fixed rate loan is for 30 years, 4.75% and 3.5% down. I used https://www.bankrate.com/calculators/mortgages/amortization-calculator.aspx to calculate how much equity I would be getting at 5, 10, and 20 years. These numbers are:

11.9% equity in 5 years (.119*250k =$29750)

21.8% equity in 10 years ($54500)

52.0% equity in 20 years ($130000)

100% equity in 30 years ($250000)

The numbers above are considering that the house stays at 250k in 30 years, but I think it will appreciate [Pflugerville / Round Rock, TX] (need to do more research)

Is this a possible equity play? Or am I better off trying other investment vehicles? Thanks.

[Llewelyn A.]

@Kelvin He

@Dennis M.

Dennis, I want to point out that Kelvin indicated that he is NOT BETTING on Appreciation.

What Kelvin is doing is betting that his 96.5% LTV loan of $240k of a $250k purchase will disappear in 30 years, which it will. That's just Math.

Additionally, he will take a $200 per month loss in the 1st year he rents it out entirely ($2,200 expenses but only approximately $2k in rents).

Let's just assume the above scenarios plays out for the entire 30 year holding period.

So Kelvin will lose $200 per month or $200 x 360 months = $72,000.

Assuming NO APPRECIATION, the mortgage disappears in 30 years.

If Kelvin then sells the property at the same price of $250k, his return would be $250k minus $72k minus $10k for down payment = $168k profit in 30 years.

Considering that Kelvin would only put in $10k as a down payment, $72k as payments towards the property over the 30 years, his investment is $82k which then returns proceeds of $250k.

If we did a non-compounding calculation of ROI we get $168k profit / $82k Invested = 204% in 30 years or 6.8% per year.

If we did a Compounded Rate of return, we get a 6.12% IRR over the 30 years. Here is the IRR Chart:

What Kelvin is saying is that this is the most pessemistic scenario where he will have ZERO Appreciation AND NO CASH FLOW INCREASES due to increasing rents versus expenses.

Kelvin can then come up with an optimistic senario, such as add 5% annual appreciation with 2% annual cash flow growth.

That would supercharge his IRR.

Aside from this, the danger, as others state, is that Kelvin cannot afford the negative 200 per month cash flow. BUT.... common guys... negative 200 per month?! I mean this doesn't kill anyone that I personally know who has disposable income to buy an investment, even for $10k savings like Kelvin.

Of course there are a ton of other considerations such as Capital Expenditures and Tax Savings, but we are not building a very complex and sophisticated spreadsheet just yet. If it were me, I would actually do it.

I would definitely look into the economic factors that are going to be driving the value of the properties in that area as well over the 30 years, however.

To me you can get the numbers completely correct, but if you don't know the economic trends that are happening, a good investment can turn into a nightmare no matter how much cash flow you are generating over the years.

There are too many examples of cash flowing properties that stopped cash flowing such as places like Detroit, Bethlehem, Allentown, etc. Generally one industry towns where the Industry dried up.

The economics is a necessity to long term buy and hold investing. If you are not doing that, good numbers can turn out bad.

But that being said, this is well within my risk tolerance level as long as there are no negative economics that will impact the next 30 years.