Is there such a thing as a cash flow positive building or house? Everybody and their cat wants one. It sounds great and I certainly advocate it 100%. How possible is it? The answer is that it is very possible but if you found such an animal in most cases you would pass it by.
Earlier this year I found a potential cash flow positive property. I bought at least 25 investors by to see the building. It was listed for $1.8 million in a gentrifying neighbourhood.
It was 7 apartments and 7 stores and it was half vacant. No one wanted it. It would have been hard to buy because banks don’t like financing half vacant buildings. The property was very well maintained and badly managed because the owner was dead. Death makes good property management too difficult for most of us. It sold at $1.2 million. The existing potential was for $180,000 in gross income a cap rate of about 14%.
What do investors want?
This is just my experience of course but investors want a clean, full, easy to manage property in a good area. They also want it to cash flow with as small a down payment as possible.
What do sellers want?
Sellers want top dollar for their investment and they aren’t stupid either. If they have a clean, full, easy to manage property in most cases they are extremely happy to keep it because it’s making them a nice income every month, they likely bought it a while ago and they have less mortgage to service than you will if you buy it. If they’ve had the building for a while they may have claimed depreciation and selling the property means they have to pay the government a large chunk of the money you are giving them.
Why do sellers sell?
You’ll see sellers sell because prices are high and they want to test the waters. If you offer them enough (not cash flow positive for you) they’ll sell.
Seller can’t manage the property – some properties are extremely challenging
Seller deferred maintenance to the point where the property no longer rents well, they can’t psychologically spend the money required, so they sell
Seller bought the property and they hate tenants and the laws protecting tenants and so they sell
Vacancy
Previous dead and their heirs want to sell
Bankruptcy
That’s the list! As you can see the more motivated sellers are not exactly likely going to have great properties. They aren’t making any money and neither will you if you don’t have an aggressive plan to manage the problems. You will be buying other people’s problems. Problems with bad tenants, bad maintenance and vacancy. The seller has given up. Lets expand on these categories one at a time.
Sellers sell because prices are high
The market is at an all time high, interest rates are low and this makes property prices go up. If you buy a property like this at a premium take as long a mortgage as you can to insulate yourself from rising interest rates. By the time you renew on a 10 year mortgage you will have decent equity and inflation will have done its work and you should be able to get higher rents.
Seller can’t manage the property
Properties in gentrifying areas and bad areas can be extremely had to find good tenants for. Ok tenants require more management then great tenants. You have to call to get the rent and go to the property and pick it up. You will have truly bad tenants applying and just one of them can cost you thousands. It’s hard to believe but there are places that don’t even take an application or make up leases.
Seller deferred maintenance
For years in Ontario we had rent controlled apartments, owners could not charge market rents. The only way to eke out a profit was to defer maintenance. Basically if you stopped fixing your building you would make more money. Vacancy rates were at an all time low so you could be reasonably sure that someone would have to rent the apartment even in horrible condition. I remember showing a place and having 80 people show up. Owners didn’t fix anything; they didn’t have to, someone would take it. Even if they fixed it up they couldn’t charge more rent. What would be the point. Some of those buildings are still around and the owners haven’t caught up to the new mentality. They have trained themselves over years of business not to spend one penny they don’t have to. With vacancy rates being the way they are now they have to upgrade their suites to compete and they can’t. The just can’t spend the money. This is a psychological problem but I can assure you it is alive and well. These building are so run down they can’t even attract renters and the ones it does attract don’t pay rent. So the owner sells his problem to you.
Sellers hate tenants and the laws
Just one really bad professional tenant will make your life a living hell for up to a year. Some landlords have the idea that it’s their property and they should be able to do what they want. They can’t. Tenants can be a real pain and owning a building can be stressful. Some people are not cut out to be landlords. It can be a risky business. Some people just want out. They don’t care and they don’t want to be in the business of owning income property.
Vacancy
The result of bad management and deferred maintenance is vacancy. In some areas you have to pick the best of the bad tenants that present themselves. It’s horrible. Sometimes the owner is too busy to figure out what’s going on until he sees red ink all over the place.
So they sell.
Death
This is pretty self explanatory.
Bankruptcy
Most investors haven’t made their money in real estate. They work or they have other businesses. Basically if you declare bankruptcy they will also sell your building to pay your other debts, lawsuits etc.
The Truth
The search for an income property is long and arduous. You are unlikely to find a property that cash flows unless you are prepared to take on another person’s problem. If you do take on another person’s problem, you need a great plan. It will be harder than you expect and it will cost more money than you expect. What kind of real estate investment you decide to take on depends on many variables. It depends on how much money you have, what your risk tolerance is and the stress you are prepared to accept. It is a lie that you will be able to make money if you don’t buy properly, aren’t committed to the process and don’t do your due diligence. you are your own best friend and don’t believe anyone who has something to gain from your acquisition. These include mortgage brokers, sellers and especially your real estate agent.
There is nothing to like about a cash flow positive property. Chances are it’s in a bad area, hard to rent, ill maintained and partly vacant. It’s not sexy or cute it’s a mess. I’ve managed properties like this, after all I do specialize in vacancy problems. It takes several years to transition the bad residents out and get better tenants. Is it worth it financially? Absolutely, but you need to be extremely prepared and well capitalized to succeed. Eventually if you do it properly you will end up with the best building in the neighbourhood and you will be able to charge more rent. I will argue anyone that there is more money in getting a 50% building to 90% than any other real estate deal.
If this kind of investing isn’t for you then you will have to buy a cash flow negative property just like most people do. It’s a hell of a lot of hard footwork to find good investments. You have to look under a lot of rocks to find a gold nugget.
Happy Buying