Kevin AmolschA Guide to Long-Term Real Estate Investing
Monthly income from rentals is becoming increasingly difficult to achieve, according to many investors. While finding a deal that will produce cash flow has become a challenge, this is especially true when focusing on low-effort, long-term leases. Although we continue to find cash flowing properties on a regular basis, it requires significant work and sometimes many offers to close a deal. This raises the question: is there ever a time it is acceptable to buy a property with negative cash flow, knowing the ultimate goal is several years down the road? Can a negative cash flow property still be a great investment and set you up for financial freedom later?
A podcast I listened to recently from BiggerPockets got me thinking about this question. The argument was that it can be acceptable to subsidize an investment if you are banking on both appreciation and the loan pay down. For example, if you can afford the payment on a rental property with cash flow from your job, you might consider a 15-year or even a 10-year mortgage to increase the pace of paying off the loan. You could sacrifice cash flow now for greater cash flow later.
Because cash flow is tough to find, the podcast suggested investors shift their focus to appreciation, specifically on great locations with the best chances of high appreciation rates. This might mean either increasing the down payment to get some cash flow or accepting negative cash flow until rents increase. As a firm believer in being conservative, I find that betting on appreciation is risky. What if the house does not appreciate, or worse, loses value? Consider a scenario where the property loses value, eroding any equity you have, making it difficult to sell and leaving you forced to carry negative cash flow.
However, there is one exception where buying a property with negative cash flow can make financial sense: when you are playing the long game. When I say long game, I mean 10 years or more. If you have a plan, stable income, and cash reserves to handle a downturn without income from rent, real estate can still be a powerful wealth-building tool. This strategy succeeds over a long period of time, when real estate historically increases in value, and you steadily pay off your debt. The spread between the home value and the loan balance increases significantly over time. It functions as a forced savings account with both appreciation in value and debt reduction working together in your favor.
When considering this strategy, focus on locations—but not solely on appreciation. Instead, focus on locations with the least likelihood of depreciation. These are areas with high desirability: inner core neighborhoods, close to transit, walkability, great amenities like parks, lakes, beaches, or mountains. This excludes speculating on future development, trying to get ahead of jobs, political influences, or other factors that might increase demand in a specific market.
While I still recommend focusing on cash flow and using the cash flow to pay off the loan quickly, buying in smart locations can work out well over many years. Limit your downside first and with some patience, you too can become wealthy in real estate!