To Break the Unbreakable Rule – Is Positive Cash Flow Necessary?

Is cash flow in real estate the be-all end-all? Or is it a nice to have but not a need to have? Let's explore!

Many investors value cash flow over all else. This can often lead to ignoring properties that have great long term potential due to location, layout, lot etc.

An Alternative Consideration 

For properties (with exceptional value) that are cash flow negative we can consider the following steps.

𝟏) Build the negative cash flow over the term of the mortgage into the initial investment

This can be included into a proforma. While it will lower the return on investment (due to more capital upfront) it can lower the stress about the property’s payments. It is essential that you have the funds set aside as hitting a cash crunch can be devastating. You should also set aside contingency funds for maintenance and vacancy.

𝟐) By making a few calculations and an assumption on interest rates we can project out future payments at the end of the term (this assumes the borrower refinances).

𝐀) If an investor purchases a $500,000 property with $100,000 down they can reduce their monthly payments in five years by $175.5 (assuming interest rates do not drop).

𝐁) If interest rates in five years are 4.5% they could reduce their payments by $561.1 per month.

𝐂) You can factor in re amortizing your reduced loan balance (at renewal), the possibility of falling rates and the potential of increased rents. This is my least preferred route and please read the warnings at the bottom of this post as this scenario has the highest risk.

A few quick metrics – Per $100,000 – Over a five year term this pay down and refinance strategy will reduce monthly mortgage payments by $43.88 (per 100k borrowed) assuming interest rates do not drop.

If interest rates drop to 4.5% in five years and re re amortize the reduced loan balance payments would drop $140.28 per 100k borrowed.

As always here is my grocery list of risks and concerns.

𝟏) Do not use this approach on any property that is not AAA.

This is a strategy that has very real risks and should not be used to by questionable properties. Personally I would only consider in areas with new infrastructure being built (IE hospitals, universities, transit ect), properties near said infrastructure (major employers, universities, hospitals ect) or properties that I strongly believe the zoning may change (IE community plan suggests an increase in density).

𝟐) It is important to also consider increasing costs over five years.

IE insurance costs increasing, rates could go even higher, utilities, major repairs ect.

𝟑) Rents could fall over the next five years, mortgage rules could change, will you qualify to extend your amortization back to thirty years (yes you do need to re qualify!)

𝟒) On the note of re qualifying – you need to plan for this. Every financial decision you make can impact your ability to stretch the payments back out (re amortize). Buying future properties, vacancies, getting a car… it can all impact you.

I want to be clear, this is not a silver bullet “you can go buy cash flow negative properties without a care in the world”. This is another perspective to consider that can open up new possibilities for the RIGHT property. It has risks and if it makes sense depends on the investors position. If you recently read my article on real estate investing (the one about running down a hill with scissors) you will know I believe in keeping large financial reserves to protect your real estate portfolio and in diversifying your assets outside of real estate.

My Opinion Negative Cash Flow Opportunities

When it comes to real estate a “C” investment property that cash flows positively is not inherently better than an “A” property that carries negative cash flow.

On the flip side, the sentiment “only buy cash flow positive properties” generally comes from decades of experience and is one of the best mantra’s for newer investors to keep them out of trouble.

The problem with “only buy cash flow positive properties” is that many investors (and sales people) have started using higher risk strategies to force positive cash flow (Air BNB, furnished rentals, mid term rents, student rentals etc.)

There is absolutely nothing wrong with these strategies (which could be argued by experienced investors to be lower risk) but we are talking about advice for new real estate investors after all.

I believe the “only buy cash flow positive properties” mind set was created to help protect newest investors and has mutated over the years. Originally I suspect (I wasn’t around in the old school days of the real estate investing world) this mindset has the unspoken caveat that if you could not find positive cash flow for long term rentals then just wait (or look at other markets/properties). For better or worse the Canadian real estate market has evolved, growing more expensive and increasingly difficult to find a cash flow positive rental (with 20% down

At the end of the day, every property can be made cash flow positive with the right down payment. When you put extra down payment you reduce the mortgage payment. It takes roughly fourteen years for the reduction in payments to equal the down payment.

An experienced investor can evaluate the extra down payment vs the opportunity cost and decide if they prefer not buying the property, putting more down or balancing the risk of negative cash flow.

There is no right or wrong approach but you need to make sure you consider the advantages and disadvantages very carefully (and ideally with multiple professionals to cash lending risk, tax risk etc.)

Find out more

As mortgage brokers we are on your team. Our job is to understand your needs, plans and wants in order to understand your mortgage needs. We then look at a number of lenders to find the best products and solutions for you.

During our time in the industry we have learned a number of tips and tricks to help you save money and to pay of your mortgage faster.

If you have any questions or would like a customized mortgage plan let us know!

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