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Negative Cash Flow Vs. Future Appreciation

by: Jeff Quintin, on February 13, 2013 - Uncategorized

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A question that is on the minds of many investors these days is whether or not they should wait to sell their property or keep on carrying the property through year after year in the hopes that it will appreciate. The best way to evaluate this is to put scenarios on paper and compare.

Let’s consider a property that was purchased somewhere in 2005-2007, for a price tag of $400,000. Assuming a 20% down payment the amount owed today is $300,000, leaving a monthly payment of about $2,300. This equals $28,000 each year in mortgage payments. Even after factoring in the annual net rental income of $13,000, your negative cash flow each year to carry the property is $15,000.

Here are two scenarios to demonstrate how this would pan out if you chose to sell now or wait for appreciation.

What Happens If Selling Now?
With the market having come down, the home that was worth $400,000 in 2007 is likely worth $230,000 today. Factoring in the selling expenses, the net proceeds from the sale will be roughly $215,000, leaving you $85,000 upside down on what you owe on the property. The question to ask is, “do I want to spend $15,000 each year to maintain this asset to one day be able to get out of it?”

How Does Selling Five Years Later Look?
Let’s say you choose to wait for five years in the hope that the market will appreciate and you can recover your initial investment. Keeping in mind that you will have an annual negative cash flow of $15,000 totaling $75,000, in order to break even on your investment you would need to sell the home for $430,000. This would yield $400,000 after selling expenses.

Remember, the market would need to appreciate by 50% in order to reach this goal – that’s 5% each year, which is a possibility only assuming a strong market. Market appreciation of 10% in each of the next five years seems unlikely at the moment.

Assuming that we did have a 10% yearly appreciation, even then it would only bring up the value of your home to $290,000 but you would still need to sell at $430,000 to break even. All the while, your annual negative cash flow continues as your resources continue to be drained.
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At the end of the day, you need to ask how long it will take for the market to come up to where you can sell your home for $430,000 when your property’s value today is $230,000. And in the meantime, are you willing to continue draining your financial resources to upkeep the home?

In my opinion, if you were going to throw $15,000 toward an asset every year, you would want it to appreciate accordingly so you can break even.

Based on this example, you can see that there would be two viable options for investors in this situation today:

1. Bring money to the table and sell the property today.
2. Sell it as a short sale, getting the lender to accept less based on today’s value.

If you would like to discuss your specific situation, feel free to call us today – we’ll be happy to go through the numbers and work out possible solutions.