How much negative cash flow is acceptable? - Posted by Gaymond Lee

Real Estate Investing Real Estate Financing
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Posted by John V, FL on August 02, 2003 at 23:49:18:

That is a great question. Seems the answer is there will always be up and down/sideways cycles. Even perennial California bull Ron Starr agreed that there were prior busts for a short period of time. Key is buy with appreciation assumption and lots of leverage only after a long down/sidways move like in the mid 90’s. Today we are at or near the end of the up cycle so is foolish IMHO to take on too much risk with negative cash flow and high appreciation expectations for the next 5-10 years. We are also in a rolling depression the likes of which none of us has ever experienced if we are under 80 years old. Seems too many unprepared real estate investors will need to be hit in the head with a ton of bricks before they see that.

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How much negative cash flow is acceptable? - Posted by Gaymond Lee

Posted by Gaymond Lee on August 01, 2003 at 02:26:29:

Hi, (Lengthy 1st post)
I recently bought a townhouse which costs me approx 1.5% (of purchase price before tax savings) in negative flow per year (due to high property taxes). I figured the rent increase after my 1 yr lease agreement is up will be reduce this to under 1% (after tax savings) since I rented it out the 2nd day after COE. I did not want to wait 1 month or longer to rent for top $ as I wanted to build up as much cash reserves from the renter’s deposit and rent payments before the 1st payment on the Trust Deed was due. I figured that if the market continues to increase at a conservative 2% a year I would be fine okay as this would be a method of forced savings. This is my 1st investment (but 3rd purchase) and it has paid off as it is in a small 8 unit complex with a smaller unit (with less upgrades) selling for $50k above my purchase (2.5 months ago) price just 2 weeks ago and another owner (with a more desirable end unit?) turning down an offer that is $110k above my purchase price last week. I was able to get the property at a discount (IMhO) as the previous owner had a pending divorce. The property is in the beach area (90266) and it seems the only way to get a neutral or positive flow is with 25-30% down. I acquired it with 10% down but actual out of pocket costs were much lower since I used the proceeds from a cash out refi on a 2nd (on primary residence) that had an outrageous interest rate and the payment didn’t increase much even after modifying the payments to reflect a continuation of the previous amortization schedule (due to new rate being less than half of the old one). I’ve taken all of the RE classes my local CC had to offer, passed the sales exam (unfortunately did not take test prior to recent purchase) to practice before I apply for the brokers exam test in Sept as the plan is to be able to handle the deal and pocket the 3% commission on every deal. I’m envious of all the msgs about buying for zero to low down and having positive cash flows. I’m happily living below my means (newer house, less desirable city) but don’t want to continue buying more properties with negative flows if that is an absolute investment no-no. The plan is to buy 1 more property (I’m thinking bad area because it will be cheap and GRM will be a lot more reasonable than the beach areas) before the end of the year and another in 2004. Are there any RE investment clubs in the South Bay area of So Cal? Thanks for taking the time to read this

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Re: How much negative cash flow is acceptable? - Posted by Dale

Posted by Dale on August 01, 2003 at 16:46:50:

I’ve lived in your area. If you want to buy and hold there you need to be very patient. Go slow, and don’t buy too many until your first ones begin to cash flow positive. Taht may take a while.

Also people get positive cash flow with little down in only some areas of the country, definitely not where you live. To get those types if deals if you want them, you’ll have to look much farther away from home.

Maybe look into other techniques on this website that might work better where you are than buy and hold - for example maybe wholesaling or rehabbing.

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There is another angle on this. - Posted by GL - ON

Posted by GL - ON on August 01, 2003 at 13:08:57:

There is another angle on this. That is the use of the GRM to predict the market. Or at least to tell when it is on your side and when it isn’t.

If you have a choice between a high GRM and a low GRM, everything else being equal, the low GRM is the better buy. But if all the properties you look at have a high GRM that tells you something too. It tells you that the whole market is overpriced and there are no bargains.

It’s like the Price/Earnings ratio in stocks. The average PE of the New York Stock Exchange is around 15-20. If it goes higher than that, the market is very high priced and if it is lower, the market is full of bargains.

Warren Buffet became one of the world’s riches men by investing in underpriced bargain stocks. In 1969 he announced he was getting out of the business - after investing successfully since the early 50’s, he could no longer find anything worth buying and he was too old to change his ways.

That was the top of the market. Over the next few years the market dropped by almost a third.

Then in 1974 he announced he was back in business. He said there were so many bargain stocks he felt like an oversexed sultan in a harem - didn’t know what to grab first. And that was the absolute bottom.

He called the market perfectly without even trying, simply because he would only buy stocks that were undervalued.

This kept him from buying Microsoft, IBM, and all the other glamor stocks of the last 50 year but it also kept him from buying Enron, Bre-X and all the other stinkers. The most exciting thing he ever owned was Geico Insurance. Also Ford and Coca-Cola. And he beat everybody in the whole world, working out of his spare bedroom in Omaha Nebraska.

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Re: How much negative cash flow is acceptable? - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 01, 2003 at 09:24:37:

Gaymond Lee–(CA)----------------------

I think you are doing fine. You are doing real estate investing the “right way,” in my opinion. If you have not read it, you might want to read my advice for beginning real estate investors, although you may not need it. However, it might stimulate your thinking. You find it by putting “beginners success” into the search function at the top of this main board of this CREONLINE.COM web site.

You sound like you bought at a very good price.

I think that, if you can take advantage of the tax beneifits, after income taxes you will find that your negative is down to about 0.80 to 1.15 of one percent of your purchase price.

Here in Coastal CA, one should be prepared to trade off negative cash flow for appreciation, in my opinion. Otherwise you either have to buy at bargain prices for quick resale or else go to other areas to buy for long-term rental positive cash flow.

Lyal’s view is, in my opinion, not as applicable in CA as it is in most other parts of the country. It is not “wrong,” but if you follow it, you will probably never buy rental properties in Coastal CA.

Other investors in your area? Probably only a couple of hundred thousand. However, real estate investing tends to be somewhat invisible. People don’t know you are a real estate investor unless you tell them.

Are you an attorney? I thought only attorneys could become real estate brokers in CA without a couple of years experience as a saleperson under a licensed real estate broker.

Good Investing**Ron Starr

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Re: How much negative cash flow is acceptable? - Posted by GL - ON

Posted by GL - ON on August 01, 2003 at 08:20:11:

I’m the first one to say “Don’t buy negative cash flow for a long term investment” but in your case the cash flow is so close to zero that it doesn’t matter one way or the other.

The fact that you are in a strongly appreciating market is another big factor in your favor.

The appreciation makes up for the neg cash flow and if rents keep pace you will be able to raise the rent and have a slight positive cash flow a year after purchase.

This is not the kind of property that gets you discouraged and makes you sell out too soon, before the big rise in price. In your circumstances it sounds like you made a good buy, and have educated yourself well about real estate investing.

The condo townhouse offers excellent investing opportunities. You can get practically as much rent as a house, but you can buy them a lot cheaper. That means positive cash flow, or at least break even, is a lot easier to achieve.

The only problem is how many like that can you afford? That is the other question. If your goal is to own say 10 properties you can only do it if they are positive cash flow.

I don’t recommend “bad” areas with certain exceptions. The exceptions are older, run down areas that are experiencing a revival. If you can buy and fix up on the fringe of such an area you can buy at the old depressed price and have a very rapid gain.

Another way to speed toward your goal is to buy multi units. You can usually get better deals, low or no down deals and pos cash flow in this type property where you can’t in single homes.

I think you are making excellent progress in your education and investing. Your post should go in the “Success Stories” so newbies can learn how it’s done.

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Re: How much negative cash flow is acceptable? - Posted by Lyal

Posted by Lyal on August 01, 2003 at 07:18:13:

Gaymond,
Any negative cash flow from an investment property is unacceptable. Spend more time here, read the forums and the vision will begin to come clear. One of the most important things I’ve learned here is that YOU MAKE YOUR MONEY ON THE BUY (first professed to me by Ed Garcia).
Hoping that you’ll get a tax break or benefit from appreciation or rent increases is just too speculative. You have no control over the market.
I feel like a parrot here because it’s been said so many times before but don’t look for properties, look for motivated sellers and you’ll find what you’re looking for.
As to the license issue, not at all necessary. The realtor’s classes will help you understand the process of buying a house but will be of little help in investing. The BEST info you can get is right here. If you haven’t read the articles, do that first, then the money ideas and the success stories. Browse all the forums (plan on several days) and search the archives for answers to questions you have. Check out the courses and books. All have been screened for the highest quality info. Then, armed with the right info, start looking for places to invest that will put money in your pocket from day one.
All the best, Lyal

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Except in California - Posted by GL - ON

Posted by GL - ON on August 01, 2003 at 13:22:01:

Before I scare you, none of this seems to apply to California. It has its own laws of economics that don’t apply anywhere else. In other places real estate goes up and down, in California it goes up and up and can go right off the scale and stay there for 30 years without a reaction.

Here is my favorite California real estate investment story. It comes from Ben Stein’s 1977 memoir titled “California Dreemz”.

January 22, 1977

Mike came to visit me in the hospital this evening. He and I talked for a long time about what I might do if I sell some screen rights and get together a little bit of money. He gave me this Hollywood fiscal advice.

“Get one of those really big houses in the flats of Beverly Hills. Put down as little as you can. Pay for it on credit. Then get a big second mortgage and buy a Rolls-Royce convertible.”

I love it. Personal finance, Hollywood style. I felt so good after that advice that I didn’t need any painkiller tonight.

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Re: How much negative cash flow is acceptable? - Posted by Lyal

Posted by Lyal on August 02, 2003 at 08:49:02:

Ron,
Always appreciate your input. It’s true I have NO feel for the market in coastal CA. I do although feel compelled to point out that the line “Make your money on the buy” comes from the Ed Garcia / Terry Vaughn seminar. Both have many years of experience investing in CA.
All the best, Lyal

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Re: How much negative cash flow is acceptable? - Posted by Gaymond Lee

Posted by Gaymond Lee on August 01, 2003 at 11:06:39:

A 4 year degree can take the place of the 2 years sales experience to qualify to sit for the CA Broker’s exam. Since my 4 yr degree was in Accounting I only had to take 6 RE classes (that’s all they offered anyway) and I was able to do that in the last 8 months. I wish I could have done it quicker but this college would not allow me to challenge the courses but rather I had to sit through the class. It takes a long time for the CA DRE to process requests so I figured I would receive some benefits by taking the sales exam first before I could qualify for the broker’s exam. Once I applied, I received a ton of job offers so I took up the free training that a local mortgage broker is offering and am working on my 1st origination (helping out a customer of mine from my own business) to learn. I might take up some free training from a RE Sales company (I have lots of time lately as my own business is a little slow and I work from home) as I thought I would be able to get more insight and leads by having access to the MLS but from the msgs I’ve read here it seems as most people bypass the MLS altogether and search out sales on their own through WTB signs and public notices of default. I figured I had to get 2 loans (and give myself the best rate) this year anyway (a refi on my primary residence’s 1st TD after the pre-pay penalty expires in Oct (but the higher rates lately might change my plans), and for the purchase of another investment property. I can only take 1 more property with neg flow so I need to get up to speed on how everyone else is doing this with positive flow and little or no down. I figured by going into a lesser area (where I personally wouldn’t want to live) I can trade appreciation for a neutral or less severe initial negative cash flow. Primarily looking for a cheap fixer duplex and grow from there.

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Re: Except in California - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 01, 2003 at 16:44:59:

GL–(ON)-----------------

California has not been immune to declining real property values in the past. In the mid 1990s we suffered the worst depression since the great one of the 1930s. Housing prices in some parts of So CA actually dropped by about 25-30%. We had a couple of other recessions, in the late 1980s, and, I have heard in the late 1970s. In some areas the nominal prices did not decline, although the real prices did decline because we had general inflation and the property values did not increase enough to keep pace with the reduced purchacing value of the dollar.

However, it may we that we will not have any declines in real values in the next twenty years. I don’t know the future, of course, but the population projections and the slow building of residential units certainly portend increased prices over the next 3-5 years. I suspect it will last longer than that.

Good Investing***Ron Starr

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negative cash flow acceptable? - Posted by Ronald * Starr(in no CA)

Posted by Ronald * Starr(in no CA) on August 02, 2003 at 11:17:53:

Lyal-------------

It seems to me that one should know as many of the rules of thumb in investing as possible. And “never any negative cash flow” is one of those rules of thumb. But, again, one needs to ask which of the three financial benefits am I after as an investor C-A-T: Cash Flow, Appreciation, Tax benefits. Then, knowing the rules, decide for oneself what one will do.

I don’t much care for negative cash flow personally. That is why I buy rent houses in OK, where the ratio of rent income to property value is much higher than here in CA. And, in 2002, OK cities had very low appreciation something on the order of 2.5 or 3%, I believe. So, I hold some properties here in CA, even with very modest cash flows or neutral cash flows. My net wealth climbed last year with little work, thanks to those houses in Sacramento area.

It is difficult for an investor to carry many negative cash flow properties from other income sources. So, I don’t really RECOMMEND negative cash flow property investing. However, I see it as a trade off which one MIGHT accept to get the glorious appreciation we have enjoyed here of late.

Negative cash flow is not GOOD. It is just sometimes NECESSARY to endure to enjoy that automatic escalator to wealth: APPRECIATION. Here in CA, appreciation is the name of the game. Negative cash flow is the price one pays to enjoy playing the game.

Now, that poster also made it clear that he bought somewhat below the market value and since he bought he has had a spectacular appreciation. So for him, so far, it has worked out well.

Good InvestingRon Starr******

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Re: How much negative cash flow? -NONE - Posted by Linda Simms

Posted by Linda Simms on August 02, 2003 at 09:07:42:

Lyal. Here you are right. Negative cash flow is an No-No. Anywhere out side of costal California and a few other places it just is not necessary to accept negative cash flow. There are too many good other ones out there. Pass on the negative and always accentuate the positive!. Now what is acceptable for Ron may be OK for him and if you are going to invest in those coastal area you may have to accept it. But, as Ron has said himself, go inland. Betting on appreciation to bail you out at the end is more risk than most seasoned investors accept. Counting your tax advantage is OK, I did it for a long time, but nothing beats having that positive cash flow and purchase price way below fixed up market value going in.

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Re: How much negative cash flow is acceptable? - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 01, 2003 at 16:13:50:

Gaymond Lee–(CA)-------------

Thanks for your comments.

Yes, for positive cash flow it is going to be easier to invest away from Coastal CA. I recommend the other parts of CA, where it is possible to get breakeven or positive cash flow. I expect continued appreciation in all of CA.

Good Investing********Ron Starr**********

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Re: How much negative cash flow is acceptable? - Posted by Erin (detroit)

Posted by Erin (detroit) on August 01, 2003 at 11:35:57:

How did you find out the 4 years of schooling could replace 3 years of being a salesperson? I have a 4-year degree and am doing sales with the next steps of getting my brokers license in 3 years. If I can bypass it, all the better. Any info is greatly appreciated.

Erin

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Re: Except in California - Posted by Joohn V, Fl

Posted by Joohn V, Fl on August 02, 2003 at 17:02:00:

With all due respect I doubt it Ron. The standard of living for the upper middle class and middle class in this country is being squeezed as we speak by China and other countries. Real Estate taxes to skyrocket as you have a budget defecit that could be catastrophic. The government is broke and the consumer is maxed out. Add in who will buy that ranch in San Jose for 650k that rents for 2200/month with 8% interest rates when the all that money that was pulled out of the stock market and low interest CD’s no longer there and people replace their old job with one paying much less. We are in a rolling depression and the risk levels on having all your money tied up in leveraged overinflated housing is enormous.

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Re: negative cash flow acceptable? - Posted by GL - ON

Posted by GL - ON on August 02, 2003 at 12:50:09:

Ron you make good sense as always. There are a couple of points I would like to bring up.

How many negative cash flow properties can the average investor afford to carry comfortably and not get discouraged? One or 2?

Now how many positive cash flow properties can he afford? 10 or 20?

Suppose the neg ones go up twice as much. The guy with the pos cash flow properties will still wind up ahead because he has so many.

To prefer the high priced negative cash flow properties would require me to believe that they will continue to appreciate more than 10 times faster than the other, even though they are starting from a much higher point. And that the appreciation, minus the neg cash flow, will outstrip the appreciation PLUS pos cash flow of the other properties. I don’t think there is enough LSD in the world to make me believe that.

Fashions change. What was once a desirable and fashionable neighborhood can deteriorate into a slum. What was once a forgotten backwater where nothing happens can become hot. I can remember (barely) when the whole Southern US was a sleepy backwater and Atlanta was famous as the setting for Gone With The Wind, and nothing else since.

And the Hollywood set once considered Beverly Hills the place to live, Malibu to be out in the sticks and Palm Springs a vacation retreat. Now they all seem to live in Northern California, Oregon, Colorado, and even Arkansas.

So maybe Oklahoma will have its day in the sun next.

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Re: How much negative cash flow is acceptable? - Posted by Gaymond Lee

Posted by Gaymond Lee on August 01, 2003 at 16:13:56:

I found out when I first signed up to take the RE courses at the local CC. The chair of the dept informed me about it

Copied from
http://www.dre.ca.gov/bexpernc.htm

Education in Lieu of Experience

Four-Year Degree: An applicant with a four-year degree from an accredited college is exempt from the two-year salesperson experience requirement. This may be verified by submitting either a copy of the diploma or transcript showing the degree earned. Regardless of the degree, the applicant must show evidence (transcripts) of having completed the eight statutorily-required courses at the time of filing the application. The eight courses may be part of the degree requirements or they may be completed separately from the degree course work.

Courses completed or degrees earned through foreign institutions of higher learning must be evaluated by a foreign credentials evaluation service approved by DRE. (Refer to RE 223.)

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some responses - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 02, 2003 at 20:59:36:

GL–(ON)-------------

You mean I may have to get together a letter explaining to my OK renters what to do when Sharon Stone moves in next door to them?

I’m not expecting much appreciation in OK, and I have not been disappointed in that department. I kind of think there will be no glitterati making it their home. There are no Teton Mountains, no skiing, I believe.

Anyway, I think you are making a very good point here. The small rate of appreciation on a lot of positive cash flow properties vs a high rate of appreciation on one or two expensive properties, negative cash flow properties. You are causing me to change my perceptions here. I’ll want to think this through some.

I have several pretty-much break even properties which I have carried along for years. Now, during the past five years or so they have appreciated greatly. The rents are going up some too. So they are not as bad in cash flow as they were. But perhaps I need to consider the redeployment of that equity into high cash-flow generators, albeit with lower appreciation.

Hmmm. I suppose one reason to like high appreciation properties is that it is effort less building. No work, it just goes up in value. An astonishing thing. Also, it feels good to see my wealth going up. However, maybe I could feel good having more pocket money to spend in wild ways. Even if my wealth only crept up.

Good Investing**************Ron Starr****************

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Comment on appreciation rates - Posted by randyOH

Posted by randyOH on August 02, 2003 at 15:35:38:

GL,
I agree with your thinking on appreciation rates. It just amazes me how most people assume that because an area has been appreciating rapidly, it will continue to do so. Like it is some law of nature that the past appreciation rate will continue into the future. A little basic math will show you that a very high appreciation rate (say 10% to 15%) cannot continue very long. The reason for that is simply that no one could afford to live there. People will move to the less expensive parts of the country.

In fact, I would go so far as to say that a market that has been appreciating at an abnormal rate for a number of years is actually LESS likely to appreciate in the future than a market that has not been appreciating at an abnormal rate.

So when you buy into that rapidly appreciating market with the negative cash flow, you are not likely to get the appreciation you need to overcome the negative cash flow. In fact, there is a substantial risk that you may experience DEpreciation. And, of course, I would point to So Calif in the late 80s and early 90s to support my case.
Randy