negative cash flow rental property

Negative Cash Flow Rental Property : Should you keep it or sell it?

The wealthy wisdom says always invest for positive cash flow. Never just chase the appreciation aspect. Rather look for a rental property that can pay you every month. No matter though, even if you have invested for cash flow, market conditions can anytime turn your positive cash flowing property to produce negative cash flow. If this is your case, you want to know whether to keep your negative cash flowing rental property and operate at losses or sell it? 

A Negative Cash Flow Rental Property is a liability. Sell it if you can`t change scenarios or it isn’t simply a temporary condition. Is there anything you can do to make your rental property cash flow positive? How much time is needed to turn it from negative to positive cash flow? Do you have enough money to ride the loss cycle till it becomes positive? If your answer is yes, keep this rental property else sell it. 

Analyze why do you have Negative Cash Flow Rental Property?

When you have to put money out of your pocket every month that is when your rental property has a negative cash flow. But if this rental property is able to provide you some cash after paying off all the expenses, you are getting a positive cash flow. So it is better you analyse why you have a negative cash flow on your rental property. 

1. Rental Property Cash Flow Analysis

Have you done cash flow analysis when you purchase this rental property? If not, this is the most likely to be a reason that you have a negative cash flow rental property. Not running rental numbers before investing into a rental property, you might have not taken all the expenses into consideration. Or, you probably have overestimated the returns. 

In any case, your rental property will keep on generating negative returns until you do the rental calculations right. Better do a rental property cash flow analysis and analyze the profitability of your rental property. 

Read: Do Rental Property Cash Flow Analysis as easy as 123

2. Rental Strategy

Rental Strategy is an important aspect in determining the profitability of your rental business. A wrong rental strategy can cause larger vacancies than usual and can make your business suffer negative cash flow for a long time. Consider these situations for an instance

  • The rental prospects in your area are mostly looking for long term accommodation. But you have an Airbnb rental which only caters to short term renters. 
  • You have lots of college or university students coming to rent your property. But as per your rental criteria, you only rent to those who have a verifiable income. You don’t consider co applicants at all. 

In both the instances, you are going to have a hard time renting your place. Vacancies will cause you to have negative cash flow. If this is your case, you better reconsider your rental strategy. 

Read: Rework your rental criteria and don`t let vacancies hurt you any further

3. Rent Rates

Charging too less or too high rents can cause your investment to generate negative returns. Is this your case? Less than market value, you might be having 100% occupancy rates but you can have an overall negative cash flow return. Charging high, your property can stay vacant for a long time and you can lose on your returns.  

Evaluate your Rent rates as per with the market prices. See whether your rental property can generate positive returns or will you keep on losing money if your charge as per market rates.Doing so you will have a pretty good idea where your rental business stands in terms of profitability. 

Read: How to increase Rent without losing even a single tenant?

4. Maintenance Repairs

Are you paying too much or too less in Maintenance Repairs? Most maintenance repairs come under the responsibility of a landlord but not always. A lot of your rental income goes back in maintaining your rental property. A general rule of thumb says if you are spending more than 50% of your rental income in maintenance repairs, you will end up with a negative cash flow.   

Likewise when you pay less in maintenance, chances are you don`t have a maintained place. And not having a maintained place, you can have a hard time renting your property. You will have high turnover rates. You have to then spend costs in re renting your place and that will ultimately add up in your expenses list. Reduce expenses and keep them less than your income to have a positive cash flow from your rental property.   

Read: What Maintenance repairs aren’t a Landlord Responsibility?

5. Mortgage Tenure

Mortgage is one of the biggest expenses tied to a rental property. Some people prefer a long term mortgage while others invest with short term mortgage. Long term mortgage comes with smaller monthly payments while short term mortgage have large monthly payments. If you have obtained financing for a short term say 5-10 years. Chances are, you are paying monthly payments that are more than what you make every month from your rental property. 

Surely, you will have negative cash flow rental property in this case. But the cost of owning this investment property will be less than say if you have financed it for 20-30 years. Having a negative cash flow is fine if this is your case. Down the line, 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. Not only this, you can even finance your investment property by paying as low as 2%-3% in down payment nowadays. But sometimes, doing so can land you in trouble and your rental investment can cause you to earn negative cash flow. 

If you have paid only 2%-3% in down payments, you have already spent a lot more than usual in upfront costs and will continue to do so in monthly payments too. This ultimately adds up in your property ownership cost and tends to provide you negative returns for the rest of your life. You are even at a risk of reaching negative equity and can lose all your equity invested in the deal. 

Read: Low down payment financing options available for a rental investor

7. Purchased at a Higher Price

When you purchase a rental property, it is advisable that you run a thorough analysis before finalizing the deal. If you have bought the rental property at a higher price than the market prices, you can generate negative cash flow from your rental property. You will be paying more for a property be it in upfront costs and monthly payments. 

No matter if you are paying more, you have to charge according to market trends. Paying more and not being able to charge as per your expenses, you will keep on generating 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 just because you feel there is a scope of appreciation? Or actually there is a scope? There is always a difference between imagination and ground reality. Simply hanging on to the assumption that real estate never depreciates and always appreciates in value, you are at a wrong place. Though it is true in some sense and it surely happens when you have all of your lifetime to have it happen. 

Keep your negative cash flow rental property if there is actually a scope of improvement. If you feel such improvements can help you in increasing rents, or in property value; keep your rental property. Else get rid of a 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 can it also be able to increase your cash flow? 

b) Cash Flow Negative Today but Cash Flow Positive Tomorrow

You can be cash flow negative today but can you become cash flow 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 is it after 5 years? You live out of state and have a rental manager that you have to pay every month. But you will be going to live in that state once you retire or your work commences in your area and will manage your own rental. 

Will you be able to become cash flow positive after these years? 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 secure financial future.

c) Opportunity Cost of Investing

Sometimes, the opportunity cost of an investment is higher than the cash flow it offers today. In simple terms, an opportunity cost is the cost you have to pay for selecting one investment over the other. You miss out on the profits and returns from the other investment that you opted to forego. Likewise, you are having a negative cash flow rental property today. But the opportunity you choose to hold the rental property over the other  may have a potential to give greater profits tomorrow.  

Suppose you sell your negative cash flow rental property and put that money in a CD(Certificate of Deposit). You will get an overall better positive return today. But what about 10 years down the line? Will the returns from a CD will be able to match with the returns from your rental property, when say your property is completely paid off? 

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?

You have taken into account every consideration in the article but still feel selling is your best bet to minimize the loss. Then you should also consider the what if of 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 case of a financed property. Surely, the buyer will want to close at a lower price from what you have purchased to ensure a positive cash flow. 
  • Still if you want to sell your rental property at loss, you can report the losses on your 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 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.

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