Most experienced real estate investors recommend buying residential and commercial properties that generate revenue, and to avoid those with negative cash flow. It’s become conventional wisdom for many, but while there’s merit to such thinking, it is possible to turn previously negative cash flow properties positive. If you can understand what is going wrong with the property and finance necessary improvements, you can turn even a high-vacancy rental into a profitable addition to your portfolio, at a lower upfront cost versus purchasing a property that is already generating income.
Negative cash flow properties can be profitable, but often requires significant investment to address all their issues.
There are inherent risks to owning a negative cash flow property, whether you’ve spent money to acquire it, knowing that the previous owner has lost money on it—or you’ve been sitting on a property as it has lost traction and slipped into the red. Depending on the problems you’re trying to address, this can be a hefty price tag to swallow on top of the lack of cash flow from the property itself. But you don’t want to just spend money blindly. You must be strategic.
If you know a property’s performance is impacted by specific onsite problems, such as deferred maintenance or a lack of amenities, investing in improvements can turn things around.
But there may be large-scale regional factors that you cannot control. These can be a major contributing factor to your negative cash flow situation, and no amount of investment can remedy.
Before you considering buying a negative cash flow property, or further investing in one you already own, you need to ensure that the property’s problems fall into the first category and not the second. If there are bigger problems, such as a poor local economy, then it may be wise to look elsewhere and cut your losses.
What types of fixable issues cause properties to have negative cash flow, and how can you address them?
The causes for negative cash flow can vary from property to property, and oftentimes there is more than one factor involved. Depending on the problems you’re taking on, it can take anywhere from weeks to months before you see financial returns on improvements and repairs.
Because of this, it is important to have an exit strategy in place. If you’ve attempted multiple solutions and aren’t seeing your desired returns, you have to either find a way to offload it before it starts taking up too much of your own money, or identify what additional fixes or improvements can be made.
Low rental income
One of the common causes for negative cash flow on a residential property is a low occupancy rate, resulting from competing properties offering similar living arrangements at a lower rate. Competitors may have purchased properties when prices were lower, and thus be able to charge lower rates. It can also be the result of a remodel making a neighboring property look safer and more attractive, or the addition of modern amenities your property doesn’t have.
The surrounding area can also play a factor. If you own multifamily housing that isn’t located close enough to shopping centers and other desirable destinations, or is in an area with high crime, your rental and occupancy rates will be negatively impacted. And this is the sort of problem that you won’t be able to fix.
This can also be a problem for commercial properties, such as strip malls and shopping centers. If a location doesn’t get the traffic businesses need to stay afloat, you can lose small business tenants. And as more empty spaces open throughout a shopping center, businesses looking for expansion opportunities may decide to look elsewhere.
Excessive upkeep costs
If occupancy isn’t an issue, and rents are well within what the local market supports, it is time to investigate the operating costs of the property. One of the biggest killers of cash flow in rental units is deferred maintenance, and the costs of addressing it.
Deferred maintenance is not just the neglect of critical property repairs and improvements—it’s also making repairs that aren’t meant to resolve the issue, but rather delay the need for more extensive repairs. For example, if you have recurring leaks from a water pipe, you might opt to patch the leak, which is a cheaper repair than replacing the pipe. But the cost of these stopgap repairs adds up, and may ultimately result in a catastrophic failure that costs many times more than a proper repair would have, and makes it that much more difficult to achieve profitability.
Property management can also be a factor in your upkeep costs. If you’ve hired or partnered with a third-party property management company, they could be costing you more than 10% of your monthly income. If their services are costing more than they’re worth, and you’re local and willing to get your hands dirty, taking a hands-on approach to managing your properties can eliminate that overhead.
Improvements and remodels
Renovations, in the form of improving visual appeal or amenities, are critical to maintaining or increasing the value of any property. Large renovations and improvements aren’t cheap, and too many such projects done all at once or in rapid succession can make an already struggling property a greater burden for an investor. Even a property that is performing well can be thrust into negative cash flow by a poorly planned remodel.
Additions and improvements are often necessary. But it’s important to be selective with renovations, rather than just throwing your money at every single problem all at once.
If limited rental income is causing negative cash flow, starting many remodels all at once isn’t going to resolve this right away, especially if you aren’t strategic with your choices of improvements. But you can justify rent increases by charging for newly added and improved amenities that are desired by tenants. Expanding parking may appeal to renters who own more than one vehicle, or more secure, covered parking may draw tenants who can afford more expensive vehicles they wish to protect. A child play area or a swimming pool can help keep tenants with children and attract new families to the property.
Some investors select a property because they want to reposition it as a vacation rental destination. Others see a traditional rental property in a location that may eventually support more well-heeled tenants as businesses move into the area. These are valid motivations, but they may not be appropriate rental strategies for a given location.
For example, a traditional rental property may be a poor fit for a major tourist destination. You may not be able to charge rents that can offset operating costs, even with good occupancy rates. Local residents could also take a pass on such a rental because of the touristy—and likely costly—nature of the area.
Alternately, an Airbnb property might sound like a good idea in a major vacation destination, but depending on where your property is located, you might be competing with many other property investors who have had the same idea. It’s also important to remember that vacation rentals are currently experiencing push back across the US, and some cities are considering stricter laws governing such properties, which could potentially reduce their income significantly.
Negative cash flow properties can be extremely lucrative investments if everything lines up the way you need. But it costs money to do this. Having limited cash reserves could make it difficult to quickly address critical issues, resulting in lost tenants and reduced revenue. A hard money lender like Socotra Capital can provide loans for residential rehab and commercial improvement projects that traditional lenders won’t lend on, giving you the cash flow you need to realize your property investment strategy.