Real Estate… Answered

Negative cash flow only makes sense in one case: you’ll make money at the sale. Not all landlords are in the long term holding business; you can profit from income-producing real estate investments in other ways too. Many investors are happy to have any income from their real estate investment, even if it’s negative. It helps cover mortgage payments and other operating costs. Then, they make money from the sale of the property. Here are a few example scenarios that justify negative cash flow:

You Plan to Convert Apartments to Condos

In high-growth areas, you can make a lot of money by purchasing apartment buildings and converting them into condominiums. I’ve never done it myself, but my aunt has made a fortune from it around San Diego. From what I understand, you have to wait until individual leases are up. You also have to watch out for rent stabilization programs and other city or county zoning issues.

But if you can pull it off, the profits are usually generous. If you’re making a 50% cash on cash return, you can usually justify a small negative cash flow during the conversion process. You’ll more than make it up at the sale of each unit.

You’re Changing the Use of the Property

Even in mediocre markets, you can make surprisingly high returns by purchasing out of place properties and then rezoning them. For example, it’s common for a developer to build a huge retail center across from an older neighborhood, dramatically increasing the traffic and commercial appeal. Families and older couples typically become annoyed with the new hubbub and decide to sell, without really researching what the property is worth.

You can make a fortune by purchasing the houses and then rezoning them for a more appropriate use. Houses directly across the street from the development might become out parcels for restaurants, fast food chains, and banks. Further back, you can convert houses into offices or apply for higher density and turn your real estate investment into a multifamily cash flow machine. Make sure you do your research on the increase in value before purchasing each property, but in most cases, it’s absolutely worth it. Value can jump by over 100% with a change in usage.

Your Real Estate Investment Is Appreciating

This one is called speculating. Most landlords will tell you it’s a bad idea, but people continue to make considerable amounts of money from it. The idea is to invest in real estate in high-growth areas and wait for it to appreciate. Many Californian investors, for example, saw their real estate investments appreciate by over 20% per year for a long time. You can also see similar trends in Washington DC and Boston.

Of course, there’s also a downside. It’s called speculating because you are betting that the market will improve. If you’re wrong, you can lose a lot of money. The bottom line is you need to have an acute understanding of the market to make consistent profit from appreciation. For that reason, it’s usually a bad idea for beginning investors to depend on appreciation. More experienced investors, on the other hand, continue to make fortunes from it. They don’t mind carrying some negative cash flow if the property is appreciating by 20% or more per year.

You’re Picking up Substantial Equity

You might also run into a situation where your real estate investment has negative cash flow but substantial equity. Usually, it’s due to financing. For example, many landlords with poor credit accept less than optimal interest rates, just to get into the game. Also, you might not have enough money for the down payment or renovations, forcing you to get a high interest hard money loan. The payments can drive your cash flow into the ground.

But sometimes it’s worth it. Let’s say you find a duplex that appraises for $300,000 and the seller is willing to accept $200,000… if you can close in 5 days. Knowing a conventional lender will take at least three weeks to approve you, you decide to borrow the $200,000 from a hard money lender at a high interest rate. You might have to deal with negative cash flow for a month or two and then refinance into a more conventional loan that puts you back in the black. The upside is you walk away with $100,000 of equity.