Would You Buy A Property With Negative Cash Flow

Negative Cash Flow

Cash flow—it’s a term real estate investors eat, sleep, and live for. Maybe it’s used in reference to bigger sums of cash flow, as in flipping, or more often it’s used in terms of the monthly cash flow that a rental property does (or doesn’t) bring in. Either way, cash needs to be flowing in for a real estate investment to be a win...or does it?

The first question every investor should ask when they are shopping for an investment rental property is whether or not it will cash flow.

The second question every investor should ask, should they find out a property isn’t expected to cash flow, is if there’s no cash flow, where will my returns come from?

There are two scenarios where negative monthly cash flow may be able to be made up:

1.  House appreciation

2.  Long-term gain (Equity)

Forced Savings

If you look at your principle mortgage payment in year one it comes out to $12,052 annually with an average monthly cost of $1,004.33 minus your negative monthly cash flow 423.00 nets you $581.33.

I refer to this as your forced savings.  Like setting aside a $100.00 per month into a 'just in case' fund you might have for unexpected expenses or for future plans such as retirement, travel, school, etc.

By investing $423.00 per month (the negative cash flow) you grow your equity by $581.33 per month.  If you choose to accelerate your payments Bi-Weekly you can decrease the interest paid resulting in an overall increase in your net equity growth.

So if you didn't purchase a negative cash flow property you would miss out on capital appreciation in our Toronto market.  Is it reckless of me to suggest that Toronto home prices are going to continue to rise...speculative perhaps and I do believe they will continue to rise especially over time.

Mo' Money Less Taxes

Using the example above if you take the $2,500.00 per month income you will generate $30,000.00 gross.

Here is where the magic comes in.  As an investment, you are allowed to offset expenses against that income.  We call this the P.I.T.M. principle.

Principle, interest, taxes, and maintenance on the property.  You don't get to actually write off the principal amount you paid on your mortgage however you do get to write off the interest, taxes, and maintenance fees.  What you can do with the property, and seeking/using a good accountant you can depreciate your property over time resulting in deferring paying tax on income earned.

Why would you consider this?  Well let's say today you are in a tax bracket over 40% and in 10 years or 20 years your asset is depreciated and you are required to pay the deferred tax on the revenue deferred.  However, because your tax bracket is likely going to be lower than it is today it could have a positive effect on how much more equity you will retain.  My advice here is to contact a very knowledgeable accountant who can explain the benefits and risks with you.

There is a saying that states; Time Value Of Money Is Important.  Would you rather have a dollar today or a dollar 25 years from now.  A dollar today is worth a lot more!

Inflation Is Eating You Alive 

According to Statistics Canada consumer price index, today's prices in 2020 are 16.09% higher than average prices since 2010. The Canadian dollar experienced an average inflation rate of 1.50% per year during this period, meaning the real value of a dollar decreased.

In other words, $100 in 2010 is equivalent in purchasing power to about $116.09 in 2020, a difference of $16.09 over 10 years.

The 2010 inflation rate was 2.35%. The current inflation rate (2019 to 2020) is now 2.25%. If this number holds, $100 today will be equivalent in buying power to $102.25 next year.

In simpler terms, waiting to buy a property next year means you likely will reduce the value of your money and buying power by 2.25%  For every 100,000.00 dollars it will only be worth $97,750.00 meaning you are going to have to save an additional $2,250.00 for every hundred thousand dollars in order to purchase your investment property.

If you waited for example from 2010 to 2010 the value of your saved dollars in 2010 is not worth that same value.  In fact, they are worth 16.09% less.

If you're old enough (come on Boomers put your hands up) and remember at one time a cup of country-style donuts coffee cost $0.50 and today a Starbucks coffee can run you $3.00 or more.

Waiting for a cash positive investment property may not be the best solution if you consider how inflation devalues that investment by waiting.

Rental Rates

The great thing about rent is that it doesn't stay there forever.  And even then if you do have a longer-term tenant you are guaranteed rental rate increases in Ontario each year.

When a Tenant does leave, which can happen every year, your ability to re-lease the property will be at current market rates and likely at a much higher rate than the current tenant is paying.  Over the time of the investment property, it is likely that the rent will increase and you will increase your equity over this time.

Taking the example above with a small rent increase of 2% per year for 5 years

1. Year 1 $2,500.00 per month x 12 months = $30,000.00
2. Year 2 $2,550.00 per month x 12 months = $30,600.00
3. year 3 $2,601.00 per month x 12 months = $31,212.00
4. Year 4 $2,653.00 per month x 12 months = $31,836.00
5. Year 5 $2,706.00 per month x 12 months = $32,473.00

As you can see on a very conservative method the value of your investment is going up exponentially over the 5 year period totaling $6,121.00 more dollars.  If the tenant does move out and you can rent the property for more than a 2% increase it will have an even greater impact on how much more money you're going to make.

What I am trying to express is don't discount buying a negative cash flow property because today it might be under-water and within a year or so it might, in fact, be cash neutral or even cash positive.