Negative Cash Flow Rental Property : Should you keep it or sell it?
The wealthy wisdom says always invest for positive cash flow. Own a rental property that can pay you every month. But it is not always the case. Even though you bought the right property with a good cash flow. Market conditions can turn positive cash flow property to produce negative cash flow. If this is your case and you are losing money every month? Get to know whether to keep this negative cash flowing rental property or dispose of it?
A Negative Cash Flow Rental Property is a liability. Sell it if you can`t change scenarios or it isn’t a temporary condition. Keep it if there is anything you can do to make your rental property cash flow positive. Calculate how much time will it take to turn it into positive from negative cash flow? And, whether you have enough money to ride the loss cycle till it becomes positive?
Analyze why do you have Negative Cash Flow Rental Property?
When a rental property provides you cash after making all the expenses, you are getting a positive cash flow. But when you have to throw money out of your pocket every month to keep your rental property business afloat. This is when your rental property has a negative cash flow. Losing money is for no good. Better analyze what is causing a negative cash flow on your rental property.
1. Rental Property Cash Flow Analysis
Not doing a cash flow analysis while purchasing a rental property is one of the reasons why most investors have a negative cash flow on their rental property. Had you run the numbers and took all the expenses into consideration? You probably have overestimated the returns.
In all, you will keep on occurring to negative returns unless you redo all the rental calculations. Perform a thorough cash flow analysis and analyze the actual profitability of your rental property.
2. Rental Strategy
Rental Strategy is an important aspect to determine the profitability of a rental business. You can expect longer vacancies and suffer from negative cash flow if your rental criteria is not up to par. Consider these situations for instance
- The rental prospects in your area are mostly looking for long-term accommodation. But you are running an Airbnb rental that only caters to short-term renters.
- You own a rental property in a college town. But your rental criteria require a verifiable income and credit score above 750. You don’t even consider having co-signers.
In both instances, you will hardly have a renter to rent your place. Your place will stay vacant which will cause you to suffer negative cash flow. If this is your case, better reconsider tweaking your rental strategy.
3. Rent Rates
Charging too little or too high can cause your investment to generate negative returns. Is this your case? Charging less than market value, you may have a 100% occupancy rate but are you even meeting all your expenses? Expect to have a negative cash flow in a long run. And if you are charging high, your property will stay vacant for a long time causing a negative cash flow again.
Is this your case? Evaluate whether your Rent rates are as per the market prices. And are the market rates really right to generate positive cash flow? Or, you will still be losing money? By doing so you will have a pretty good idea of where your rental business stands in terms of profitability.
4. Maintenance Repairs
Are you paying too much or too little for Maintenance Repairs? A lot of your rental income goes back to maintaining your rental property. And, sometimes the landlords even pay for those maintenance repairs that aren`t the responsibility of a landlord. A general rule of thumb says if you are spending more than 50% of your rental income on maintenance repairs, you will end up with a negative cash flow.
Furthermore, some landlords take things into their hands when it comes to maintenance. They either don`t want to pay anything for maintenance or else wish to pay pennies. If you are one such landlord, chances are you don`t have a maintained place. And when you do not have a maintained place, you will have high turnover rates. You will then spend more trying to re-rent the place. This will ultimately add up to your expenses list and you can occur to a negative cash flow
5. Mortgage Tenure
The mortgage is one of the biggest expenses tied to a rental property. Some people prefer a long-term mortgage while others opt for short term mortgage. Long term mortgage comes with smaller monthly payments while a short-term mortgage has a large monthly payment. Chances are you are paying more in monthly payments than what you make every month from your rental property if you have opted for a 5-10 year term mortgage.
If this is your case, you will definitely have a negative cash flow rental property. Although, the cost of owning this investment property will be less than say if you have financed it for a term of 20-30 years. Occurring a negative cash flow is still fine in this case for an average investor as you are going to stay profitable in the long run.
Pro Tip: Charge about 1% of your property value in monthly rents. Doing so, you will stay profitable and will earn an overall positive cash flow.
6. Low Down Payment
Financing is one of the great financial instruments available to mankind provided you know how to use it. And if you are one such investor who has financed your rental property by putting as low as 2%-3% in down payment. There are high chances that your rental investment will produce negative cash flow.
Those paying only 2%-3% in down payments often pay higher monthly payments. Even they pay higher closing costs too which ultimately adds up to the property ownership costs. All of this tends to provide a negative return for the rest of their life. Is this your case? It is always better to have a little more skin to avoid occurring to negative cash flow.
7. Purchased at a Higher Price
When you purchase a rental property, you must run a thorough deal analysis before buying the property. If you have bought the rental property at a higher price than the market prices, you will certainly generate negative cash flow. Paying more not only includes the price paid to the seller but also includes the upfront costs associated with the purchase.
You paid more doesn`t translate into charging more. You have anyway charge according to market rates. You have paid more, your expenses are high. But you can`t charge as per your expenses. Eventually, you will suffer negative returns on your investment property.
When To Keep a Negative Cash Flowing Rental Property?
It is important to understand when to hold onto a negative cash flowing property. Let`s simply not hang over a negative return generating investment property because you feel it will appreciate in future. It can actually be a liability that you will regret investing in later. You should then hold your negative cash flow rental property if your situation qualifies any of the below factors.
a) Future Growth Indicators
You are holding your negative cash-flowing rental property as you feel there is a scope of appreciation. Is there actually a scope? There is always a difference between imagination and ground reality. Simply hanging on to the assumption that real estate always appreciates and never loses its value, you are at the wrong place.
Keep your negative cash flow rental property when there is actually a scope of improvement. A Scope of improvement should be such that it can help you increase rents or your property value. Else get rid of liability as soon as possible. Keep a close eye on upcoming trends that can affect your markets in a good way.
Cash Flow is always the king of investing. Market Trends can appreciate the value of your property but will it also increase your cash flow?
b) Cash Flow is Negative Today but will be Positive Tomorrow
You are having cash-flow negative today. But can your cash flow be positive tomorrow? Your expenses can be out of board today. But will they come down tomorrow? A five year mortgage is hurting you today. But what it will be after 5 years? You live out of state and a rental manager is managing your rental property. You have to pay him every month. But will you be going back to this state once you retire or your work commences?
By managing your own and not paying to a manager, will you become cash flow positive? If yes, continue to operate at a loss today and reap its benefits tomorrow. You are not only building equity slowly in your investment property but will be a master of a secured financial future.
c) Opportunity Cost of Investing
Many times, the opportunity cost of an investment is higher than the cash flow it offers today. An opportunity cost is a cost you have to pay for selecting one investment over the other. The missed opportunity cost is the profit and returns from the other investment that you opted to forego.
Say, you are having a negative cash flow rental property today. But you choose to hold the rental property over the other investment.
Suppose if you don`t hold and sell your negative cash flow rental property. You put that money in a CD(Certificate of Deposit) and get an overall better positive return today. And on the other hand, if you hold a negative cash flow property, you will lose money.
But imagine 10 years after. Will the returns from your CD be able to match the returns from your rental property, when your property will be completely paid off assuming you have the money to ride the negative cycle?
A profitable rental property can easily churn out 12% annual returns on your investment compared to 2.3% return on a CD.
What if you want to sell your Negative Cash Flow Rental Property?
But, I feel selling is my best bet to minimize the loss. So should I sell it now? Expect this when you are selling a negative cash flow rental property.
- It is hard to find a motivated buyer for a negative cash flowing property.
- Even if you find a buyer, you can encounter a negative equity situation in the case of financed property. A buyer who is purchasing negative cash yielding property will certainly want to close at a lower price than what you have purchased.
Tip: You can report the losses to reduce your net taxable income.
Tax Deduction Benefit on a Negative Cash Flow Rental Property
A negative cash flow rental property might seem a problem to you. But it can provide you tax benefits that will be in your interest. Instead of selling your negative returning rental property, you can take tax benefits which makes more financial sense.
Do you Know?
A rental property generating $4800 in losses annually can benefit a taxpayer by $1150 whose annual gross income is $100,000. Deduct $1150 from $4800, your net loss is $3650 only considering a 24% tax slab.
The IRS allows the taxpayer to offset losses from your negative return generating rental property. If you own a single rental property, you can use the losses from this property to offset income from other sources. The IRS in this case allows you to deduct up to $25000 from your taxable income if your annual gross income is less than $150,000. Further if you own multiple rental properties, you can use the loss from one property to offset the combined income from all rental properties.
It is OK to have Negative Rental Property!
It is pretty okay to have a negative rental property if you know what you are doing and where as an investor you are heading. There are thousands if not millions of negative cash flow rental properties in the US itself. Not every one of those thousand rental properties is a bad investment. Analyse your situation and take action accordingly. Still if you feel worried, here are few exit strategy you can consider
Getting Equity Out of Negative Geared Rental Property
You always have equity tied to a rental property. If you feel your investment is not reaping your right returns and you have some better investment plan. You can always put out equity from your property through negative geared leveraging.
Building Equity in Long Run
The benefit of having a rental property is that you build equity slowly with other people’s money. Even if your property is generating negative returns, you are stuffing equity every month. You can use this equity anyway you want in the future. You can fund your retirement, or may consider converting this rental property into your primary residence some years later.
Appreciation works in Long term
Counting for Appreciation in the short term is surely not a safe bet to put in your investment cycle. But, if you see appreciation in real estate in the long term never disappoints. The prices of real estate can go up and down according to market trends and various other economic factors. But if you compare the prices, real estate definitely appreciates in value because of our ever falling purchasing power of dollars.