Sunday, June 26, 2005

The Swamp Ape & Negative Cash Flow

Negative Cash Flow. I get a lot of requests for "a good beachside investment property that will break even or generate a little cash". Folks, that has become the swamp ape of the Florida coast. In other words, they are rumored to exist, some sightings have been reported but no actual photos can be found (except for the one below and it is somewhat suspect).



With recent years seeing unprecedented buying of second homes and investment property on or near the beach, the supply of rental properties is huge. Rental rates have barely budged in years while selling prices have headed for the stars. What that means for investors is that income can no longer be a criteria for making your buying decisions. If you must have positive cash flow, you haven't been and won't be buying beachside unless you are paying all cash or making a substantial down payment. Don't let the dreaded phrase, "negative cash flow" scare you away. There are some extreme exceptions to this such as high-occupancy, short-term rentals that are owner-managed combined with interest-only loans. At any rate, let's explore a real world example.

Example; an oceanfront condo in Cocoa Beach that just sold for $380,000 this month is next door to an identical unit for rent at $1350 per month. That's $16,200 in income before any management fees. This particular unit can expect about $8800 in condo fees, property taxes and insurance. If the new owner has an 80% mortgage at 5.75% for 30 years his annual mortgage expense will be $21,288. That boils down to cash out of pocket at $13,888 per year. There are other variables such as tax savings, repairs, vacancies, damages but the fact is that this new owner had better have around $1157 per month of extra money to take care of his new investment. Does that make this a bad investment? Not when you consider that this same unit according to tax records has appreciated at 38% per year since it was last purchased in 2003 and stands a good chance of continuing to appreciate. These rates of appreciation can't possibly continue, you're probably thinking. I agree except that all the new supply of oceanfront condos approaching and exceeding a million dollars has pushed a large number of buyers down into this lower price range and continues to do so. There is a far greater supply of buyers willing to pay $500,000 for a unit than there are buyers for million dollar units. Building has not slowed and demand is still high so I expect a reduced but substantial rate of appreciation to continue for select price ranges. Any investment in real estate at this stage of the game has risk. Interest rates could skyrocket, the so-called "bubble" could burst and everything will have been a bad investment. However, if you choose your targets carefully you can mitigate that risk and enjoy healthy returns on your investment barring a catastrophe. Make sure you know what areas of the market are moving, what areas are not and don't walk away from an otherwise good investment because of negative cash flow.

In our example above, this owner will make over $20,000 a year after debt service and expenses if appreciation cools to 10% and will still make money at only 5% appreciation per year. He also has the possibility of having another 38% year in which case he stands to make a healthy six figure return in one year. I measure all my investments by comparing risk and reward. The possibility of making six figures on the high side and breaking even on the low side meets my criteria. Do your own due diligence and if you're buying in another market, find a guy like me who understands and studies his market and use him to help you select your properties. If you're buying in Cocoa Beach or Cape Canaveral, you've found your man. Email me at larry@southcocabeach.com or call me at 321.917.5786 and I'll help you locate the perfect property.

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