Faced with Cash Flow Negative?
Any real estate investor looking to own rental property has visions of accumulating a portfolio of steadily appreciating properties that spit cash out each month from committed, satisfied tenants who pay their rent on time and never quit. While this happens, it’s a real estate fantasy land for many. The truth is that the property is not always valued, it needs repairs and constant regular maintenance, and tenants move out creating vacancies, often leading to negative cash flow.
Negative cash flow occurs if property expenditures exceed the amount of income generated by the property. This sounds obvious but some new investors skip the primary cost not reported in MLS listings or other documents when initially measuring the numbers for an income property purchase; the debt service… The deposit of the mortgage.
Many investors seem less worried with negative cash flow, being assured that it will ultimately pay off in potential appreciation to offset a monthly deficit of a few hundred dollars. For some men, it certainly worked well; but this is a dangerous game to play. When property values do not go up as expected and the only benefit is a small equity pay-down, an eventual pay-off may take much longer than anticipated. This kind of uncertainty makes me nervous, which is why I advise to make sure that the get-go cash flow is positive when buying property for a long-term hold.
In realistic terms, landlords of one or more single-family homes or even duplexes, triplexes and four-plexes struggle at one time or another with negative cash flow problems.
Below are a few possible solutions for varying degrees of remedying negative cash flow. Some may operate, depending on your property and situation, while others may not be possible due to the construction design, construction size, lot size, location, zoning, amount of equity, etc. When embarking on a new strategy, please do due diligence and consult with your attorney.
Having possession of a short-term lease.
For both the owner and the tenants, a short-term lease to own could be a solution. Buyers who are unable to qualify for a mortgage are expected to lease their own plan. They usually have no good credit, confirmable earnings, or downpayment required to qualify for a conventional mortgage. The tenant eventually buys the property from the landlord in a traditional lease to own.
Briefly explained, the tenant has to pay upfront a small downpayment that is credited back to the tenant at the time of purchase, typically from 1 to 5 years down the road. The occupant pays the rent of the owner’s market value as well as an agreed-upon sum above the rent throughout the period. At the time of purchase, this balance above the rent will also be credited back to the owner.
All parties benefit from this approach. In the future, the owner is entitled to buy the house at a fixed price agreed upon or an appraised value minus the amount of accrued credits from the original downpayment and the amount above the monthly payments.
The owner’s value is double. We obtain an initial cash injection from the downpayment; enjoy uninterrupted rent plus a sum above the lease and have substantially reduced management and maintenance costs as the occupant views the house as their future home. The effect is higher cash flow and practically no maintenance costs to address the negative cash flow problem.
Renting for the short term.
Short term rental is a niche market sought by very few property owners, although the return may be extremely lucrative. If your property is situated in the vicinity of a business area, a hospital or health care facility, a university or school, an airport, a tourist zone, or one of Canada’s several oil or gas production areas, there may be an opportunity to regularly receive rents above the market value.
Most firms hire short-term contractors and move their staff from various areas of the country. People also prefer to stay rather than a hotel in a “homey” setting. For these furnished rooms, you can charge a higher lease price that will still be less costly for the client than keeping their workers in a hotel. Try to secure a long-term contract with the company if you choose this approach.
You can find another opportunity with new families in your city. Newly relocated people looking to buy a home in a new town or city may prefer a short-term rental in a home rather than a hotel as they get to know their new surroundings before purchasing a home. These can be short-term rentals or mid-term rentals that often order up to three times market rent.
Find a partner for a joint venture.
Most workers make excellent salaries and are “married” in their jobs. Many are interested in real estate as an investment vehicle but have no time or knowledge to take part in the day-to-day business. In return for a percentage of capital gain from appreciation, this individual would become a joint venture partner and be used for a capital injection to reduce the negative cash flow.
If due to lack of maintenance, the reason for the negative cash flow is a difficulty in retaining tenants (the number one reason for tenants to move), this capital can be used to make necessary changes or modifications to build a more attractive estate, thereby attracting better tenants. Rents can be upwardly modified.
Another explanation for negative cash flow may be based on the local economy or real estate cycle timing. For many factors, vacancy rates can be high in a city. As a result, tenants enjoy some affordable options, often combined with benefits for landlords. The capital of the joint venture partner can be used to keep property expenditures at “break-even” until the process of real estate passes to its next step where appreciation and rental increases begin again.
Rent more space.
It may be possible to rent rooms as opposed to apartments depending on where the property is located. If the estate is close to a school, college or health center, you may be able to convert the rooms into “self-contained” units somewhat more. You’ll need to outfit each unit with a mattress, dresser, desk and maybe a mini-fridge to accomplish this. The tenants will share the common living space, kitchen, bathroom, and parking space.
In the case of student housing, both the parents and the student must sign the leases. It means that parents are equally responsible for any harm etc. This system can work for more than just students. It can be perfect for graduate students, airline pilots, nurses, teachers, temporary placement workers, project volunteers, mission people, or any other situation where people need several months of housing at a time. You can get a lower cumulative lease sum that can address the negative problem of cash flow.
In any of the above situations, it is suggested to include a set of “house rules” to be agreed upon and signed by each occupant. This can address things like parking, storage, cooking duties, washing clothes, cleaning duties for common areas, yard work, noise levels, etc.
Separate facilities for sale.
A property may include multiple facilities that may be paid off the premises to the occupant or citizens. You may add a coin-operated washer/dryer, pay for the use of the garage or basement/attic space to increase revenue from the current tenant(s).
To store RVs, boats, jet skis, trucks or cars, non-tenants can rent space in the garage or driveway. The garage could be leased for any number of items to a person doing car repairs or as a storage unit. If the estate is situated in a downtown area, you may be able to rent the driveway to corporate employees for daily or weekly parking. You might even lease out a planting area depending on the size of the yard or acreage.
Conversion of the suite.
You may have a large house with the conversion potential to a building with 2 or 3 units. This needs cash injection, but in the long run, it can pay off beautifully. It is best to start every conversion using unused or underused space like a basement, an attic, an outbuilding, a storage room or even the garage itself.
Adding a small kitchen, bathroom and maybe bedroom to any of the above mentioned scenarios can be seen to increase revenue significantly.
Any change requires the city bylaws to be reviewed. The suite must adhere to fire regulations whether the suite is considered unauthorized or licensed. Check with your local fire department for a copy of your municipality’s fire code regulations.
Holiday rentals and B & B.
If your property is situated in a nice area and is conducive to its physical layout, you might be able to convert it into a bed and breakfast. Of course, in order to carry on such a business, you must be inclined towards such a business and a proper license, but this can lead to an excellent cash flow.
Adding a new house or a new one.
To create an additional suite, you can add square footage to the existing building. The municipality has to approve this plan. Your lot can be divided and another home, duplex or even triplex can be built.
This is a long-term strategy that will require assistance from a joint venture partner or funding sources but can potentially more than double your current income and give you a significant capital gain if you sell the newly built assets.
Changing the funding.
Typically, every landlord has a list of expenditures with the largest debt service or mortgage payment. A refinancing could minimize the mortgage payment by lengthening the amortization or reducing the interest rate. A lower cost of loans would increase the cash flow.
Programs of state.
Many government programs can provide a grant or forgivable loan to make your home accessible for people with disabilities and affordable housing through government subsidies and other government programs.
The proposals above are to encourage a landlord to hang on to their property and eventually to be saved from the dangers of negative cash flow. But, in some situations, selling the house, cutting losses, stopping bleeding, and taking your lumps may be better. Solving problems like negative cash flow is part of the growth and prosperity of any company.
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