Investing in Rental Properties: Cash Flow Positive and Cash on Hand
During the height of the housing bubble, a lot of real estate investors made mistakes by buying homes that didn’t cash flow. Many people ignore the numbers and didn’t buy investments based on proper evaluation.
How do you properly evaluate a rental property? Well, it needs to generate positive cash flow (meaning the costs of the mortgage and maintenance are more than covered by the rent). If that number isn’t positive, then it’s not a good investment. Here is how to calculate rental property cash flow.
According to Terry Sprouse, the author of Fix Em Up Rent Em Out, one of the safest ways to make money in real estate is to turn your residence into a rental instead of selling it. While it’s a great strategy, this is difficult to do in California because most properties don’t pencil with positive cash flow.
This is why I decided to buy rental properties out of state. And I bought with the intent to hold them for a long time. Many California investors bought to flip. When they didn’t sell, they had to rent the properties.
But so many people got in over their heads. The New York Times recently reported on the number of non owner-occupied homes in foreclosure:
Here in Nevada, which has one of the highest foreclosure rates in the country, 28 percent of mortgages that were in default earlier this year were for homes not owner-occupied, more than twice the national average, according to the bankers group. Arizona and Florida, both leaders in foreclosures, are also well above the national average. In California, 22 percent of the properties lost to foreclosure this year were not owner-occupied, according to ForeclosureRadar.com, which tracks California foreclosure auctions.
What’s the moral of the story? Investors didn’t have cash on hand to cover their mortgages and expenses in case the properties didn’t sell or rent. Investing in real estate is the equivalent of running a small business. Cash flow is everything.
I’ve learned this first hand. I own three rental properties and never had problems with any of them… until recently. Here’s the story:
Property #1: I had a tenant live there for five years. Unfortunately, the tenant died and the property became vacant. In August, I spent money to get it rent-ready and I’ve been trying to get it leased ever since. It’s November – I’ve been covering the mortgage now without a tenant for four months. Moral of the story: a real estate investor needs cash on hand to cover things when it’s not rented.
Property #2: I’ve owned this one for three years with two different tenants. The first tenant was problem-free. The current tenant pays late. I started the eviction process two months ago and gave her a second chance when she paid back her late rent but she’s paying late again. I’ve had to start the eviction process again. Moral of the story: a real estate investor needs cash on hand to cover things when tenants pay late or make partial rent payments.
Property #3: I’ve owned this one for two years. I’ve had two tenants and both were problem-free. Unfortunately, the second tenant just moved out when her lease was up. I’m in the process of trying to get it re- rented. Moral of the story: a real estate investor needs cash on hand to cover things when it’s not rented.
Get the picture. For five years, I never had a problem. And now, I’m covering a lot of mortgages. It’s a drain on cash flow. But I’m fortunate to have the cash because I’ve planned ahead for a down cycle. Sure, I hate spending my cash this way, but this is the cost of doing business and real estate investing is a business.
Many people wanted to get into real estate investing during the housing boom because it offered a way to make a quick buck. For some this paid off. For others it didn’t. For me, it never was about getting rich quick. My strategy has been buy and hold with numbers that work and cash on hand to ride out the tough periods.
What about you? Any real estate investing challenges to share?