A Negative Cash Flow Can Pay Off if Property Appreciates in Value
QUESTION: What do you think of investing in rental houses in a good area which has been appreciating nicely in value but which will produce a negative cash flow of about $300 per month?
ANSWER: We just lost several readers who are not familiar with the term negative cash flow. It means the property produces less rental income than the cost of mortgage payments, property taxes, insurance and other operative expenses.
For example, if a rental house produces $1,000 per month rent but it costs $1,200 monthly to operate, then it has a $200 negative cash flow each month.
I generally do not recommend buying properties that have a negative cash flow. However, I have and continue to buy real estate that has a negative cash flow if it is appreciating handsomely in market value and will probably continue to do so.
For example, I own a rental house that produces only $925 per month rent but it costs me $1,047 for the mortgage each month. But this house appreciated at least $10,000 in market value last year, so I consider that to be a pretty good investment despite the negative cash flow.
To more directly answer your question, a modest negative cash flow is justified if the property is appreciating in market value and will probably continue to do so in the future. However, if the market values of homes in your town are not appreciating, don’t buy negative cash flow property.
Heir Looking for a Profitable Investment
Q: I recently inherited just over $40,000 from my mother who died in Germany. I want to invest in real estate. As a U.S. immigrant almost 15 years ago, and now a proud U.S. citizen, I appreciate what great opportunities this country offers compared to my homeland.
My wife and I bought our home about six years ago and it has been our best investment, except for our three children, of course. But we are uncertain how to invest this $40,000. We have very adequate income, over $100,000 in liquid assets such as CDs and money market accounts, and we have a $30,000 bank credit line plus credit cards for use in emergencies.
We are debating if we should use the $40,000 as a down payment on a rental house. Or perhaps you can suggest something else. What do you recommend is the best way for us to earn maximum real estate profits for the long term?
A: Congratulations on your success since immigrating to the United States. I find it amazing how hard immigrants will work to become successful here, as compared to some of us lazy native-born Americans. But now I’ll get down off my soapbox and answer your question.
In my opinion, fix-up houses are the best real estate investments. However, I hasten to add, only houses that can be upgraded at minimal cost should be acquired as investments. Your goal should be to add at least $2 of market value for each $1 of upgrading cost.
Look for houses needing basic work such as painting, repairing, cleaning and landscaping. Avoid houses which need major structural work, although they can be profitable if you buy at a low enough price.
After you have upgraded the house, then you can decide to either keep it as a long-term investment (called a “keeper”) or sell the house for a quick profit (called a “flipper”). Either way, it is hard not to be successful if you buy at a low enough price to earn a handsome profit after the fix-up work is completed.
Long-Term Leases Not Good for Landlords
Q: My husband and I are considering buying an apartment building. We realize apartments are not especially profitable, but we want a place to park our money, perhaps benefit from market value appreciation and get a little tax shelter too. We found a very nice, luxury 12-unit building in top condition.
But the problem is many of the apartments are leased for up to five years to what I call blue-hair rich little old ladies. I feel these long leases hurt the building’s potential. What do you think?
A: I think you are correct. Long-term leases benefit tenants more than landlords. If you buy that building you will have to honor those long-term leases.
As a general rule, luxury apartment buildings are not good investments. In addition to the difficulty of renting expensive apartments, tenants in high-class buildings usually expect more services than do tenants in lower-class buildings. I realize the luxury building you are considering is probably a pride of ownership building but that type of property usually is not a profitable investment.
Risks of Limited Partnership Deals
Q: A friend has invested in a small group which earned over $50,000 profit on the sale of an apartment building which was upgraded and resold within a year. The same developer is now offering a similar limited partnership on another apartment building. Do you think I should invest?
A: I cannot advise whether or not you should make a specific investment. However, you should realize that when you invest in a real estate limited partnership you are placing your fate in the hands of the general partner who manages the investment. Personally, I do not like group investments, as I prefer to buy properties alone so I can make my own mistakes.
