Cash Flowing a Mid Term Rental

[Krysten Zarembski]

Those that are locking in new mid term properties - are you cash flowing? I know this is not the most ideal time to buy with interest rates, so just curious to hear how everyone is doing in the mid term rental space, in particular.

[Michael Kazalas]

With today's market I think it's important to get creative with sourcing/structuring deals in order to make them strong investments. A few things to think about: Can you inherit the current financing terms?, Buy property off market to cut out some seller costs and get the deal at below-market value, Would an interest-only loan be best for your hold-term and strategy?, Would the seller consider keeping a partial equity position and retain prop management duties? (this helps expands your geographic targets if you don't have to manage), etc. 

What are you targeting for returns whether it be IRR or cash on cash? Happy to connect if you'd like

[Wes D.]

Hi @Krysten Zarembski!

This is a really good question and one I was asking a year ago when I decided to jump into the MTR business. My conclusion then was this: if an investment pencils as cash flow breakeven or a small positive cash flow, using conservative underwriting assumptions, it would be worthwhile to buy despite the high interest rates.

Real estate investing has three main sources of wealth building: cash flow, appreciation, and tax benefits. So I figured that if I could avoid negative cash flow, the other two sources would carry us until rates declined and we could refinance to lower interest expenses. Lower expenses means higher cash flow. Furthermore, if rents rise in the coming months/years, this too would increase cash flow. 

When underwriting, I did not use these positive assumptions about declining rates or growing rents. It needed to be at least cash flow neutral to meet our "buy" requirements.

One year later our thesis is working. Our net operating income (NOI) margin is 54%. After subtracting interest expenses from NOI, our cash flow margin is only 7.4%. But it's positive!

With a half point rate reduction by the Fed, our HELOC rate was reduced by the same amount, and we've begun the refinance process. The property appraisal came in at a 5.3% increase versus our purchase price.

On tax benefits, last year we had a tax loss on our MTR business that lowered our personal taxes by an amount equal to 20.8% of our MTR gross rental income. In other words, this is cash we didn't need to spend (to pay taxes) due to our MTRs.

Taken together, cash flow of 7.4%, appreciation of 5.3%, and tax benefits of 20.8% is a promising start for us. The tax benefits have been the largest source for cash income so far; in future years this will likely be lower because much of our tax savings has been due to one-time costs related to purchasing and furnishing a new property. Depreciation will continue to provide tax savings for years to come, of course.

Appreciation isn't cash earnings, of course, until the property is sold, but it does factor into the overall wealth building opportunity in real estate investing. And it grows tax free.

I hope this is helpful to you, Krysten, as you figure out how to proceed. I recommend Real Estate Rookie by Ashley Kehr; she covers these topics better than I've done here. For MTRs specifically, I recommend 30-Day Stay by Zeona McIntyre and Sarah Weaver; they helped us run a lean operation. Both are published by BiggerPockets.

All the best!

-Wes

[Jonathan Styer]

My clients have been cash flowing well. You need to buy strategically and then market yourself well. We have really high demand for MTRs here in Columbus so that definitely helps - our properties are usually booked by referral before we get them listed. 

For us, its simple supply and demand. We generally expect to see 2-2.5x gross rent vs. LTR market rent. 

Happy to chat if you have any questions. 

[Krysten Zarembski]

@Jonathan Styer Columbus has actually been on my radar! I have family that just moved there. A lot is moving that way so I could be a great area. 

[Krysten Zarembski]

This is a great overview @Wes D. Thank you so much for this thought out reply and your personal experiences. Really helpful!

[Krysten Zarembski]

Good thoughts @Michael Kazalas!

[Jonathan Styer]

Quote from @Krysten Zarembski:

@Jonathan Styer Columbus has actually been on my radar! I have family that just moved there. A lot is moving that way so I could be a great area. 

Happy to chat about our market if you're ever interested!

[Peter Stewart]

Quote from @Wes D.:

Hi @Krysten Zarembski!

This is a really good question and one I was asking a year ago when I decided to jump into the MTR business. My conclusion then was this: if an investment pencils as cash flow breakeven or a small positive cash flow, using conservative underwriting assumptions, it would be worthwhile to buy despite the high interest rates.

Real estate investing has three main sources of wealth building: cash flow, appreciation, and tax benefits. So I figured that if I could avoid negative cash flow, the other two sources would carry us until rates declined and we could refinance to lower interest expenses. Lower expenses means higher cash flow. Furthermore, if rents rise in the coming months/years, this too would increase cash flow. 

When underwriting, I did not use these positive assumptions about declining rates or growing rents. It needed to be at least cash flow neutral to meet our "buy" requirements.

One year later our thesis is working. Our net operating income (NOI) margin is 54%. After subtracting interest expenses from NOI, our cash flow margin is only 7.4%. But it's positive!

With a half point rate reduction by the Fed, our HELOC rate was reduced by the same amount, and we've begun the refinance process. The property appraisal came in at a 5.3% increase versus our purchase price.

On tax benefits, last year we had a tax loss on our MTR business that lowered our personal taxes by an amount equal to 20.8% of our MTR gross rental income. In other words, this is cash we didn't need to spend (to pay taxes) due to our MTRs.

Taken together, cash flow of 7.4%, appreciation of 5.3%, and tax benefits of 20.8% is a promising start for us. The tax benefits have been the largest source for cash income so far; in future years this will likely be lower because much of our tax savings has been due to one-time costs related to purchasing and furnishing a new property. Depreciation will continue to provide tax savings for years to come, of course.

Appreciation isn't cash earnings, of course, until the property is sold, but it does factor into the overall wealth building opportunity in real estate investing. And it grows tax free.

I hope this is helpful to you, Krysten, as you figure out how to proceed. I recommend Real Estate Rookie by Ashley Kehr; she covers these topics better than I've done here. For MTRs specifically, I recommend 30-Day Stay by Zeona McIntyre and Sarah Weaver; they helped us run a lean operation. Both are published by BiggerPockets.

All the best!

-Wes

Totally agree - Wes nails it here. There are many ways to make money in real estate, and cash flow is only one of those ways. That strategy is the more dependent on the current market conditions (specifically interest rate). When your strategy is more on the tax/depreciation side of things, you can make a lot more money and the current market conditions don't factor in much. So, you can absolutely make money now with real estate, and the mid term strategy is a great one for both cash flow and tax/depreciation. My personal investing strategy is more in line with what Wes is doing and I make WAY more on my properties through taxes and depreciation than I do in cash flow (specifically my short term rentals that I self manage). 

That strategy is market/area specific though. My market (Indianapolis) is an excellent one for this strategy and there is a lot of demand here for furnished mid and short term rentals. It's a strategy that has grown in demand *because* of the higher interest rates due to the higher potential income (vs traditional 12+mo leases). 

I would also argue now is a great time to buy because of the interest rates. Of course this is market specific, but in my market (Indianapolis) we are still in a strong sellers market. When rates drop I anticipate demand to increase and inventory will probably stay about the same, so prices will rise. Like the saying goes - you date the rate and marry the house. I'd rather pay less now with a higher rate that I can refi out of than wait until they are lower and pay more (and probably have worse terms in the contract too due to multiple offers). 

[Jimmy Lieu]

Quote from @Krysten Zarembski:

Those that are locking in new mid term properties - are you cash flowing? I know this is not the most ideal time to buy with interest rates, so just curious to hear how everyone is doing in the mid term rental space, in particular.

Hi Krysten! In Columbus OH, we're still seeing decent cash flow on MTRs, even with higher rates. My clients are focusing on medical districts for traveling nurses/residents - near Nationwide. They're typically hitting 7% cash flow - not the 15% we used to see in 2021 but still workable if you buy smart. Happy to connect and answer any questions you may have.

[Wes D.]

Quote from @Krysten Zarembski:

This is a great overview @Wes D. Thank you so much for this thought out reply and your personal experiences. Really helpful!

 Oh good, Krysten, glad to hear. All the best on your investing journey!!