Monthly cash flow is one of the most important aspects that real estate investors consider when buying a rental property. Cash flow is income from an investment property minus the operating expenses. Income comes from rent and other charged services such as laundry, gym membership, and parking. Expenses, on the other hand, include mortgage payments, utilities, insurance, property taxes, rental property management, repairs and maintenance, and other miscellaneous ongoing costs.
If the rental income equals the rental expenses, then the investment property is said to be at a break-even point. When the expenses are less than the rental income, the investment property is said to have positive cash flow. When the expenses exceed the rental income, then the investment property is deemed to have a negative cash flow. A negative cash flow rental property is one that costs you more money than it earns each month. Having negative cash flow means that you will be paying for some of the monthly expenses with your personal income.
To find out what cash flow is and how to calculate it, check out our video below:
Most real estate investors only look for investment properties that produce positive cash flow and shun properties with negative cash flow. It is true that there are a number of benefits that come with positive cash flow real estate investing. In fact, successful real estate investing relies on it. But did you know there are times when it’s actually okay to buy a negative cash flow rental property? Not only is it okay, but there are actually real estate investment strategies that can be applied to turn a negative cash flow property into a successful income property.
Here are 4 instances when it is okay to buy a negative cash flow rental property.
1. When There’s a High Possibility for Future Capital Growth
It can make sense to buy a negative cash flow rental property if it has the potential for capital growth. Often, you can find negative cash flow properties in areas with high potential for appreciation in the future. These are typically locations where the real estate market trends are about to take a turn for the better. If the negative cash flow of the property is not very significant and you are confident in the future capital appreciation, then it could make for a good real estate deal.
The potential for real estate appreciation negates the fact that the property is making you lose money monthly. With the increase in the value of the negative cash flow investment property, it can later be sold at a much higher price than the initial purchase price. It is a good investment opportunity if the capital gains of the property are higher than the costs incurred in maintaining the investment property during the ownership period.
However, it is important to note that hoping for capital growth is speculating. You are not guaranteed that it will happen. If you are going to go for capital growth, it is advised that you perform thorough market research, buy the property during a down market, and do so with cash. If you buy the investment property using a mortgage, do the math and ensure that you are getting enough appreciation to make up for the interest. You can even consider using the increase in value to refinance your property to buy more rental properties.
2. When Renovating an Investment Property to a Higher Standard
Another circumstance where investing in a negative cash flow rental property is lucrative is when a real estate investor wants to renovate the property for better use. By repairing and renovating the current investment property to a higher standard, the investor will be able to charge a higher rental rate, resulting in more rental income. Consequently, higher rent will change the property into a positive cash flow rental property.
This can be done by adding amenities, replacing old and inefficient systems, etc. Having efficient systems can also reduce the ongoing costs that eat into the rental income. To learn more about the types of real estate renovations that are worth your time and money, read Property Renovation 101: What Improvements to Make for High ROI.
3. When Changing the Use of the Property
It is also okay to buy a negative cash flow rental property when you want to change the use of the rental property. By changing the use of the property, it will be able to yield more profit than it does currently. For instance, the current owner may be renting out on Airbnb and is suffering from negative cash flow because the rental strategy is just not right for this particular location. If you’ve done your neighborhood analysis and find out that a traditional rental strategy will yield much higher rental income, then it can be worth it to buy this negative cash flow rental property.
4. When Flipping the Investment Property
Negative cash flow rental investing may also be okay when a real estate investor is flipping a house. Positive cash flow will not be the main objective here since the investor is not planning to hold the property long term. The key to success with flipping houses is to have a set plan on renovations and be ready to market and sell the property as soon as it’s ready. You will have to be cautious of the real estate market you flip properties in as trends can change and force you to hold onto a negative cash flow property longer than you expected!
The Bottom Line
Most real estate experts support the idea of buying positive cash flow properties when holding real estate long term. However, buying a negative cash flow rental property is not always a bad thing. In fact, there are people who have made a lot of money in real estate buying negative cash flow properties.
There are certain situations when it is okay to buy this type of investment property. If your investment strategy does not depend on the existing monthly cash flow or you have a solid plan on how to turn things around, then it may be okay to buy a negative cash flow rental property.
Should you buy a negative cash flow rental property? The answer to this question will depend on the scenario. While these real estate deals can be very lucrative, many stars need to align for them to work. Do your due diligence before buying a negative cash flow rental property to avoid losing money. Be sure to conduct investment property analysis with Mashvisor’s investment property calculator to help you make the best decisions.