If you’re a rental property investor, why would you ever buy properties without cash flow? Does it ever make sense to do so? Most traditional investors answer “no” emphatically; Thoughtful Real Estate Entrepreneurs, on the other hand, see a broader perspective. In this episode, Jeff discusses the scenarios in which it might make sense to consider buying a rental property without cash flow.
Let me ask you a question. Would you buy a property that didn’t have cash flow? Now I’m not talking about a flip, or something that’s just temporarily vacant the day you buy it, then you’ll place a tenant the next day. I mean, something where the cash flow on that property is not positive.
In today’s episode, we’re going to discuss what most people answer to that, but then we’re going to also discuss a different way of looking at it. So, let’s cue the theme song and we’ll jump right into it.
Welcome to Racking Up Rentals, a show about how regular people, those of us without huge war chest of capital or insider connections, can build lasting wealth acquiring a portfolio of buy and hold real estate. But we don’t just go mainstream looking at what’s on the market and asking banks for loans, nor are we posting We Buy Houses signs are just looking for “motivated sellers” to make lowball offers to. You see, we are people-oriented deal makers, we sit down directly with sellers to work out win-win deals without agents or any other obstacles, and buy properties nobody else even knows are for sale. I’m Jeff from the Thoughtful Real Estate Entrepreneur. If you’re the kind of real estate investor who wants long term wealth, not get rich quick gimmicks or pictures of yourself holding fat checks on social media, this show is for you. Join me and quietly become the wealthiest person on your block. Now let’s go rack up a rental portfolio.
Thank you for joining me for another episode of racking up rental show notes for this one can be found at thoughtfulre.com/e97. Please do us a big favor by hitting the subscribe button in your podcast app; it just takes a second and it really helps send a message back to the platforms that people are listening. It also helps them tell other thoughtful real estate entrepreneurs about our show. Thank you so much for doing that, onward with today’s episode.
In today’s episode we are going to talk about this idea of buying properties that you know do not have cash flow. Here’s how this topic started. In my mind, I thought it would be an interesting question to pose to different groups. So, I went on to my social media channels, I posted this question and just said simply, “would you buy a property without cash flow?” Probably not surprisingly, most of the responses said, “Well, if there’s no cash flow, then you must be banking on appreciation and if you’re banking on appreciation, that’s silly. That’s gambling, that’s speculating. That’s not investing.” So, I would follow up and I thought, ‘Okay, interesting. Are there any conditions under which you would buy a property that had no cash flow?’ Mostly the answers were no. Now people said, Sure, if I was buying it to intentionally resell it for a profit very quickly, that’s fine. I wouldn’t worry about cash flow. Or if it’s simply temporarily vacant when I buy it, it’s been between tenants and, it’s a four-plex and two of the units are vacant, I’m going to lease it right up. So, it’s technically got negative cash flow at the outset of my purchase, but we’re going to take care of that right away. They said, “Sure, we do that but aside from that, there are not any conditions in which we buy properties without cash flow.” Now, I’m generalizing lots of different answers, of course. But that was the general vibe, theme, and spirit of the answers. I thought to myself, you know, maybe I’m the guy who just looks at everything more globally, or I’m the guy with the weird perspective. I don’t know. But to me, that seems like a very simplistic perspective. It’s like saying, somebody would just walk up to you and say, well, there’s only two good things in real estate, cash flow and appreciation; and if you can’t rely on appreciation, which you can’t, cash flow is the only thing that matters. When I rephrase it, or paraphrase it like that, that just seems so simplistic.
I have a perspective that I wanted to share my thoughts on with you today. If it were true that there’s only two good things about real estate; if that were true, no one would ever buy in markets like my own, where the prices are high compared to the rents that come in. Appreciation is not guaranteed, of course, yet. People do buy in those markets every day. I am one of them. As I look around my city, I see all these buildings are owned by somebody. So, it begs the question, well, if nobody would ever buy something that didn’t have cash flow, and nobody feels like it’s smart to bank on appreciation, how are all these buildings getting purchased? Well, of course, the broad and basic answer is that everybody has different criteria. Everybody has different goals and objectives, different needs and just simply different ideas of what a good deal looks like. I wanted to share just a couple quick reasons why I personally would and often do consider buying properties that don’t have of cash flow, that are not going to be simple, quick flips. The purpose of this episode is not to give you an exhaustive list, or a checklist of every single reason why you could or should consider buying a property that doesn’t have cash flow, but simply to make the point that there is a bigger picture in many cases. It’s always important to remember to keep a look at that bigger picture. So, let me just give you three examples that came to my own mind about reasons why I very well might be willing to buy a property that didn’t have cash flow.
The first one is pretty simple and straightforward, which is I would say, if the property has the ability for me to add tremendous value to it and transform it. Now this could be physical value, it often is physical value, it could have something to do with what the zoning might allow that this property is not currently taking advantage of, you know, for instance, if the property is zoned for eight units, but there’s only four units on the property, that would be a good example of physical improvements, that combined with zoning type of improvements and maximization of potential. It could be a financial transformation by making other improvements to a property, such as adding other income streams like laundry, or paid parking or paid storage and things along those lines. But the simple point of thinking about transformation is that what you buy, and what you end up with, might not be the same thing. If what you buy is immediately something that doesn’t produce the cash flow you’re looking for, but you know that you actually can produce that cash flow with some of these other ideas for vision that you have, then that’s definitely a reason that I personally would consider that.
Secondly, what if this property were some sort of what you might call a strategic acquisition like, in other words, it’s not just a property that exists on a cart in a vacuum of its own, it’s actually part of a bigger picture related to maybe another piece of property. Maybe it’s something else that you already owned, maybe there are some economies of scale, because this property happens to be in very close proximity to something else that you already own. Perhaps this property is something that somebody else needs, and by you buying it, and taking control of it you have sort of inserted yourself into their plans. Now they have to cooperate with you in some in some way. For instance, if you saw that a developer was buying up certain pieces of land in a certain area to create a development and you happen to control one of those pieces of land, then that’s something that would give you some power and some leverage, and that by itself might be plenty of reason to buy a property, even if it was not cash flowing. Another example would be what’s called an assemblage where you are putting together contiguous parcels of land that can be then combined into a larger piece of land to facilitate a much larger development, right? So, if you own two lots next to each other, and you want to buy the third lot, and the fourth lot now, based on what’s allowable in that zoning, etc., you would be able to do something significantly different with the four-lot property than with just the simple one lot property. So, it could be some sort of a strategic acquisition where this particular acquisition isn’t just something that makes sense by itself. But it’s something that makes sense in the greater, grander perspective of the bigger picture of your portfolio or what you are doing.
The third reason that I’ll share with you today, and again, this is not to be an exhaustive list, but just to point out that there are definitely other reasons why you might buy a piece of property. Aside from cash flow, or simple market appreciation. This is one thing I do all the time. I might buy a property because of the terms I’m able to negotiate. Now, this comes back to something that we call supercharged seller financing, when I negotiate to buy a property with seller financing, that’s a great day. But when I negotiate to buy a property with supercharged seller financing, that now makes the promissory note and the terms that I have negotiated with that seller have a much higher level of value. It gives the terms I’ve negotiated just as much value and sometimes even more value than the property itself. It is very possible, and I do this frequently to buy a piece of property not because I want that piece of property, but because I want the terms that I was able to negotiate and that by itself might be a very good reason to buy and hold onto a piece of property even if it’s not really producing cash flow.
There are probably lots of other reasons as well why you very well might consider buying a property that does not have cash. Cash Flow, that you’re not just simply, “banking on appreciation for” and that’s a point I wanted to make as well. When I hear that term “banking on appreciation,” I really kind of cringe because banking on appreciation sounds like someone is saying, you are buying a property you are then closing your eyes crossing your fingers and saying a prayer and hoping that the market says it’s worth more in the future than it’s worth now. And that’s certainly one version of appreciation. But another version of appreciation is where you force equity, where you force the appreciation, you actually manipulate it and control it through the improvements you were making. You know, if you own a property that’s valued in a commercial real estate kind of way, using the income approach to value like let’s say a 10-Plex, it’s not a mystery, that if you increase the NOI by $1,000 a month, then you are increasing the value of the property. That’s not debatable, that’s not arguable, that’s not helping that the market just thinks this property is nicer. That’s the actual simple math of how cap rates and net operating income work. So, it’s a very different to just sort of hope for appreciation versus to create your own appreciation through strategically making improvements to your property.
Here’s what I want to leave you with. You buy properties every time because something about those properties is awesome. Now, that awesome thing can be cash flow, and that’s fantastic, but it doesn’t have to just be cash flow. You can buy something simply because it has a single element of awesomeness. I like to think of my portfolio as a chess game. I am intentionally adding pieces to my chessboard that have value that I know will serve me in the greater grander picture of my chess game. It’s not just about that one chess piece; It’s about the whole chess game. With that, I encourage you to think holistically, don’t get stuck in just templatized rules of thumb. I mean, templatized rules of thumb can be helpful guidelines for helping you kind of frame up your own thinking on something but don’t get stuck in those simplistic perspectives. One thing you know I love to talk about is the difference between having an entrepreneur’s mentality in an investor’s mentality. Think like the entrepreneur, think in terms of vision, don’t just see what’s there, see what could be there. If the investor just thinks about what they can place their resources into, and what kind of return they can get the entrepreneur says, “what value do I see here?” How can I create opportunity with this situation, distinguish between banking on appreciation and forcing your own equity through your own talents and your entrepreneurship and the principles of creating value? Yes, it’s cash flow that makes a property sustainable, right? If you have a property that is upside down significantly every month, that’s not something you can do forever. But you can have a property that does not contribute cash flow to your portfolio, but it can still contribute other extremely valuable things to the bigger picture of your portfolio, your business, and what you’re trying to accomplish.
That’s it for today’s episode of racking up rentals again Show Notes can be found at thoughtfulre.com/e97. Please do us a big favor by hitting the subscribe button in your podcast app and rate and review the show; I so appreciate that.
Did you know that we have a Facebook group for thoughtful real estate entrepreneurs too? It’s called Rental Portfolio Wealth Builders and we would love to have you join us there. You can search rental portfolio wealth builders on Facebook of course, or you could just type group.thoughtfulre.com into your browser and the magic of the internet will take you right there. If you liked this episode, please take just a second to screenshot it and post that screenshot to Instagram; tag us @thoughtfulrealestate. I will see you in the next episode.Until then, this is Jeff from the Thoughtful Real Estate Entrepreneur signing off.
Thanks for listening to Racking Up Rentals where we build long term wealth by being a win-win deal makers. Remember: solve the person to unlock the deal and solve the financing to unlock the profits.