Most people get involved in rental property management because they want to make money. But sometimes, making money is more complex than it first appears to be. For example, if your goal is to make as much money as possible, then you would only want to select the properties with the highest rate of cash flow – in other words, the ones that generate the most revenue, proportional to expenses.
Already, you can probably imagine a few flaws with this idea. For example, what if there’s a property with a slightly lower cash flow rate with much greater growth potential? Certainly, it’s worth debating which properties would be better in the long term.
We can stretch this challenge even further, however.
What about negative cash flow properties? Are they ever worth considering?
What Is a Negative Cash Flow Property?
In real estate, cash flow is a measure of how much money a property is generating, compared to how much it’s costing. A property with positive cash flow is one that makes a consistent profit. A property with neutral cash flow is one that breaks even. A property with negative cash flow is one that consistently has greater expenses than revenue.
At first glance, a negative cash flow property seems like it’s never worth considering. Why would you ever pay money for a property that costs you $3,000 a month but only brings in $2,500 a month? This would result in a $500 a month loss, ultimately costing you $6,000 a year.
When Are Negative Cash Flow Properties Worth Considering?
Surprisingly enough, negative cash flow properties are worth considering in certain circumstances. The key here is to remember that negative cash flow is only harmful for as long as it persists – and even when it does persist, it can be offset by other factors.
These are just a handful of scenarios that could make a negative cash flow property worth considering as an asset:
- When the negative cash flow is temporary or inconsistent. First, it’s possible that the negative cash flow is either temporary or inconsistent. For example, if you’re eyeing a property in a neighborhood that has tremendous potential for growth and the property is significantly underpriced, it’s easy to imagine a reality in which revenues increase, expenses stay the same, and the negative cash flow property becomes a positive cash flow property. A month or two of negative cash flow is also nothing to be concerned about; in fact, most properties experience negative cash flow at least occasionally, in isolated circumstances.
- When the negative cash flow is a byproduct of poor management. You can also consider negative cash flow properties if the negative cash flow is a byproduct of poor management that’s soon to change. For example, let’s say the current owners of a rental property have grossly mismanaged it, failing to screen tenants and neglecting even the most basic home maintenance. A better owner, with better management, can quickly make negative cash flow a non-factor.
- When there’s significant potential growth. Growth potential also has the possibility of negating the damage of negative cash flow. As a simple example, let’s say a property has a negative cash flow of $200 a month, or $2,400 a year. However, it’s in an area poised for growth in both rent prices and home purchase prices for the next decade. If you can increase rent even slightly, or if your property value increases even slightly, this loss may be worth taking in the present.
- When you’re planning to renovate. Renovating a rental property isn’t always the best idea. But sometimes, it can breathe new life into a property that’s been neglected or misused. If you suspect the negative cash flow is attributable to the damaged or deteriorated state of the property, a renovation could be all it takes to go from negative to positive.
- When you’re changing the use of the property. Changing the use of the property could also be a solution to the negative cash flow problem. For example, if the previous owners were using the property as an Airbnb rental and losing money on it, you could take ownership of it and generate positive cash flow with a proper rental strategy.
- When you’re interested in flipping. If you’re planning on flipping a house, cash flow may not even enter the equation. Your goal is to find good deals on promising properties, and properties with negative cash flow tend to be underpriced compared to their contemporaries. Just make sure you estimate the cost of repairs and renovations conservatively to avoid overspending or taking on too much risk.
- When you expect major appreciation. In many cases, merely breaking even on a property is good enough since the property will appreciate in value every year. If you see property value appreciation greater than the negative cash flow rate, the investment can be called a success. However, the dynamics of this particular situation aren’t exactly common.
Taking a Step Back
Now, that said, not every negative cash flow property is worth considering. And true to your intuition, negative cash flow is a terrible detriment to the average property. Only in exceptional circumstances does negative cash flow become a negligible factor, so it’s on you to do your due diligence and make sure you make the most fiscally responsible decision. Negative cash flow is a genuinely bad thing – it’s just not the immediate disqualifying factor that many investors believe it to be.
Do you take a negative cash flow property with huge potential upside over a consistent positive cash flow property with questionable potential? How do you compensate for this risk in your property portfolio? And how do you manage a negative cash flow property to maximize its future profitability and value? These are hard questions to answer, but it’s much easier to answer them when you’re working with an Austin property management company that’s invested in your success. If you’re ready to get started with a free consultation, contact Green Residential today!