An investment property can generate positive, break even or negative cash flow, sometimes all during the same year. Cash flow in real estate is the difference between a property’s rental income and operating expenses, including the mortgage payment. It is basically the money left over at the end of each period after all of the rent has been collected and the bills paid.
Positive cash flow property is where rental income covers all of the expenses with remaining money as the profit.
Negative cash flow does not generate enough rental income to pay for the operating expenses and debt services. Investors must contribute personal funds to cover the shortage.
Break even cash flow is when a property generates just enough to cover the operating expenses and mortgage, leaving no money left over.
Some investors purchase a property with negative cash flow knowing then can purchase it at a discount and turn it into a profitable rental property. Before an investor does this, they should determine why the property isn’t generating enough cash. Some negative cash flow properties can be fixed, but sometimes they can not.
Negative cash flow can result if the monthly rent price is too low or vacancy levels are too high. The investors can run the rent comparables to determine the fair market rent and then approach the tenant with the increase before renewing their lease. Although some investors shy away from this because they are worried the tenant will leave, most tenants usually know what they are renting for. Keep in mind, it may cost the tenant more to move then accept the rent increase. High vacancy is when the rent is too high compared to similar homes.
Negative cash flow can also result when operating expenses consistently run over budget every month. Deferred maintenance can sometimes be a cause of this. It is common for landlords to ignore maintenance issues until forced to fix them. In some cases, hiring a property manager can help with this. They routinely conduct inspections of the inside and outside of the home to identify items in need of repair.
Updating or remodeling a property is sometimes necessary to attract a more qualified tenant willing to pay a fair market rent. Depending on the market, a tenant may be willing to pay more rent for updates. This may take more time to generate extra rental income to recover the initial out of pocket costs.
4 Instances when it is okay to buy a negative cash flow rental property:
1. When flipping the Investment Property – Have a set plan on renovations, market the property and sell as soon as it’s ready. Keep an eye on rental market when doing this that nothing changes.
2. When Changing the use of the property – Example would be current use of Airbnb and changing to long term rental.
3. Renovation an Investment Property – Touched on this above
4. When there is possibility for future capital growth – These can be found in areas with high potential for appreciation in the future.
When holding real estate long term, most experts support the idea of buying positive cash flow properties. 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. This situation is appropriate when your strategy does not depend on the existing monthly cash flow, or you have a solid plan to turn things around.