Are you facing negative cash flow?
Every real estate investor looking to own rental real estate dreams of accumulating a portfolio of properties that are constantly appreciating and that are turning in cash monthly from dedicated and happy tenants who pay their rent on time and never leave. Although this exists, for many this is a real estate fantasy land. The reality is that property is not always appreciated, ongoing regular maintenance and repairs are necessary, and tenants do moving, which creates vacancies, which sometimes leads to negative cash flow.
Negative cash flow occurs when a property’s expenses exceed the amount of income the property generates. This sounds obvious, but when initially crunching the numbers for an income property purchase, some new investors overlook the primary expense that is not documented in MLS listings or other reports; the debt service… the mortgage payment.
Some investors seem less concerned about negative cash flow, content that covering a few hundred dollars a month shortfall will eventually pay off in future appreciation. This has certainly worked well for some people; however, this is a risky game to play. If property values don’t rise according to expectations and the only gain is a small principal payment, it can take much longer than expected for a final payment. This type of speculation makes me nervous, so I personally recommend that when buying a property for long-term holding, make sure it’s cash flow positive from the start.
Realistically speaking, homeowners who own one or more single-family homes or even duplexes, triplexes, or quadruples struggle with negative cash flow issues at one time or another.
Below are some potential solutions to remedy negative cash flow to varying degrees. Depending on your property or situation, some may work while others may not be possible due to building structure, building size, lot size, location, zoning, amount of equity, etc. Please do your due diligence and consult with your attorney before embarking on any new strategy.
Create a short-term lease with option to buy
A short-term rent-to-own could be a solution for both the owner and the tenants. A rent-to-own strategy is designed for buyers who do not have the ability to qualify for a mortgage. They typically do not have good credit, verifiable income, or the required down payment to qualify for a conventional mortgage. In a standard rent-to-own, the tenant ultimately purchases the property from the owner.
Briefly explained, the tenant is required to pay a small down payment that is credited to the tenant at the time of purchase, typically 1-5 years in the future. Throughout the term, the tenant pays the landlord the market value of the rent, as well as an agreed amount on top of the rent. This amount above the rent is also credited to the tenant at the time of purchase.
This strategy is beneficial for both parties. The tenant has the right to purchase the home in the future at an agreed-upon fixed price or an appraisal price minus the number of credits accumulated from the down payment and the amount over the monthly payments.
The benefit to the owner is threefold. They receive an initial cash injection from the down payment; enjoy uninterrupted tenancy plus more than rent; and have significantly reduced maintenance and management obligations as the tenant treats the house as their future home. The result is increased cash flow and virtually no maintenance costs, which should solve the problem of negative cash flow.
short term rental
Short-term rental is a niche opportunity that very few homeowners pursue, although the return can be extremely lucrative. If your property is near a commercial area, a hospital or health care facility, a university or college, an airport, a tourist area, or in one of Canada’s many oil and natural gas production areas, you may there may be an opportunity to obtain rents above market value in the short term.
Many companies hire short-term consultants or relocate their employees from different parts of the country. People often prefer to stay in a “home” environment rather than a hotel. You can charge a higher rental amount for these furnished units, which will still cost the business less than putting your employee in a hotel. If you choose this strategy, try to secure a long-term contract with the company.
Another opportunity may be found with families that are new to your area. Recent transferees looking to buy a home in a new city or town may prefer a short-term rental in a home over a hotel as they become familiar with their new surroundings before committing to a home purchase. These can be short to medium term rentals often reaching up to three times the market rent.
Find a joint venture partner
There are plenty of professionals out there who earn a great income and are “married” to their careers. Many are interested in real estate as an investment vehicle, but do not have the time or knowledge to participate in the day-to-day business. This person would become a partner in a joint venture and be used for a capital injection to eliminate negative cash flow in exchange for a percentage of the appreciation capital gain.
If the reason for the negative cash flow is a difficulty keeping tenants as a result of lack of maintenance (the number one reason tenants move), this capital can be used to make necessary improvements or adjustments. to create a more desirable property, therefore attracting better tenants. Rents can be adjusted upwards.
Another reason for negative cash flow may be based on the local economy or the timing of the real estate cycle. Vacancy rates can be high in an area for many reasons. As a result, renters enjoy many cheaper options, often accompanied by incentives for landlords. The joint venture partner’s capital can be used to keep property expenses “break-even” until the real estate cycle moves into its next phase, where appreciation and rent increases begin again.
rent more space
Depending on where the property is located, it is possible to rent rooms instead of apartments. If the property is near a university, college, or health center, you may be able to convert the rooms into somewhat more “independent” units. To accomplish this, you’ll need to furnish each unit with a bed, dresser, desk, and perhaps a mini-fridge. The tenants would share the common room, the kitchen, the bathroom and the parking lot.
In the case of student housing, have the parents sign the leases as well as the student. This holds the parents equally responsible for any damages etc.
This arrangement can work for more than just students. It can be ideal for graduate students, flight attendants, nurses, teachers, temporary employees, assigned volunteers, people on missions, or any other scenario where people need housing for several months at a time. Obviously, you may receive a higher aggregate rent amount, which may solve the negative cash flow problem.
In any of the above cases, it is recommended to include a set of “house rules” that each tenant must agree to and sign. This can address things like parking, storage, cooking, laundry, common area cleaning, yard work, noise levels, etc.
Rental of separate amenities
A property may have a number of services included in the rent that may be charged to the tenant or to persons outside the premises. To increase income for existing tenants, you can install a coin-operated washer/dryer, charge for use of the garage, or basement/attic storage.
Garage or driveway space may be rented to non-tenants to store RVs, boats, personal watercraft, trucks or cars. The garage can be rented to a car repair person or as a storage unit for any number of items. If the property is located in a downtown area, you can potentially rent the driveway for daily or weekly parking to corporate employees. Depending on the size of the garden or the area, you could even rent an area for gardening.
You may have a large home with the potential to be converted to a 2-3 unit building. This obviously requires a cash injection, but it can pay off in the long run. It’s best to start any conversion using unused or underused space, such as a basement, attic, outbuilding, room above a garage, or even the garage itself.
Adding a small kitchen, bathroom, and perhaps a bedroom to any of the above scenarios can significantly increase revenue.
Any conversion requires checking with the city charter. Whether your suite is considered unauthorized or licensed, the suite must comply with fire regulations. Check with your local fire department for a copy of the fire code regulations in your municipality.
Vacation rental or B&B
If your property is located in a nice area and is conducive in its physical layout, you could turn it into a bed and breakfast. Of course, you must have the inclination for such a business and a proper license to conduct such a business, but this can result in excellent cash flow.
Add an addition or another house
You may be able to add square footage to the existing building to create an additional suite. This strategy must be approved by the municipality. It is possible to subdivide your lot and build another house, duplex or even triplex.
This is clearly 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 or give you a significant capital gain if you sell the newly built property.
Changing the financing
Any landlord usually has a list of expenses, the biggest being debt service or mortgage payment. A refinance could lower the mortgage payment, perhaps by lengthening the amortization or lowering the interest rate. A reduced loan payment will increase cash flow.
There are a number of government programs that can provide a grant or forgivable loan to convert your home into conductive for disabled renters or affordable housing for individuals with government subsidies and other government programs.
The above ideas are to allow a homeowner to hold on to their property and ultimately be rescued from the perils of negative cash flow. However, in some cases, it may be better to sell the property, cut your losses, stop the bleeding, and take your lumps. Resolving situations like negative cash flow is part of any investor’s growth and success.