Negative Cash-flow in Real Estate Investment

Navigating Negative Cash Flow in Real Estate Investment

In the realm of real estate investment, the concept of negative cash flow often sparks a debate among investors: is it truly beneficial to carry such a financial burden on investment properties?

In recent times, many investors find themselves in this predicament due to the surge in interest rates. Those who made purchases back in 2022 and 2023 are particularly affected, many investors find themselves locked into fixed mortgage terms spanning five years. Consequently, even as interest rates decrease, their mortgage payments remain stagnant until the term’s conclusion.

This situation could translate into substantial negative cash flow over the span of five years, with condo investors potentially facing around $8,000 in losses annually (see chart below).

Interest Rates Impact Real Estate

Interest rates have a profound impact on the real estate market, influencing both property prices and cash flow dynamics. When interest rates are low, borrowing becomes cheaper, stimulating demand for real estate as investors find it more affordable to obtain mortgages. This increased demand tends to drive up property prices as buyers are willing to pay more for homes and investments. Conversely, higher interest rates make borrowing more expensive, reducing affordability and potentially dampening demand, which can lead to lower property prices.

Moreover, interest rates directly affect the cost of financing for real estate investors. Lower interest rates translate to lower mortgage payments, which can boost cash flow for property owners. However, higher interest rates can squeeze cash flow as mortgage payments increase, potentially reducing profitability for investors.

The chart below for a typical 1 BR condo in Square One illustrates how changes in interest rates affect our Mississauga condo prices.

As interest rates increased, our prices experienced a decline. However, with anticipated drops in interest rates in the upcoming months, we can expect prices to rise once again. This downward trend in interest rates could attract investors back into the market, as they seek opportunities with improved cash flow prospects.

Year202120222024
Property Price$600,000.00$600,000.00$550,000.00
Down payment25.0%25.0%25.0%
Mortgage amount$450,000.00$450,000.00$412,500.00
Amortization30 yrs30 yrs30 yrs
Interest rate2.2%5.0%4.5%
Monthly costs (Approx.)
Mortgage$1,706.00$2,402.00$2,080.00
Property tax$210.00$210.00$210.00
Condo fee$400.00$400.00$400.00
Condo insurance$30.00$30.00$30.00
Repairs etc.$50.00$50.00$50.00
Total rental expenses$2,396.00$3,092.00$2,770.00
Total rental income$2,400.00$2,400.00$2,400.00
Cashflow (E&OE)$4.00-$692.00-$370.00

The critical question arises: does this financial strategy make sense?

Recently, we talked about how to avoid being house poor for existing and prospective home buyers. Similarly, savvy real estate investors should understand the importance of evaluating their return on investment (ROI) comprehensively.

This includes careful analysis while choosing between Condominiums and Freehold Properties to invest in.

Investors should assess factors such as the initial down payment, property buying expenses, negative cash flow (rental income minus the rental expenses), potential future selling costs, and the projected selling price.

Additionally, prudent investors should also factor in the costs associated with leasing, repairs, replacement of appliances or major systems and other tenant move-in and move-out costs.

Bear in mind that while rental income might grow over time, it could be counterbalanced by rising property taxes and condominium fees (for condominiums).

An astute investor should undertake comprehensive analysis, carefully balancing these expenditures against the potential returns.

Is Converting Basements into Basement Apartments a Viable Strategy?

On a similar note, homeowners who decide to convert their basements into apartments, investing considerable amounts in anticipation of stable rental income, should conduct thorough financial analysis before committing their savings.

Is it truly worthwhile to invest $50,000 to $60,000 to yield a net return of $12,000 (or any comparable figure), especially at the expense of sacrificing living space and privacy?

Can it be more prudent to deploy those funds in avenues that offer similar returns with less active involvement than being a landlord in Ontario?

All these questions underscore the necessity for investors to conduct thorough financial assessments and weigh the opportunity costs before committing to any investment strategy. Seeking guidance from a qualified financial advisor can be beneficial to assess your portfolio, ensuring it’s well-diversified and employing optimal strategies for maximizing your resources. This includes exploring all type of investments such as RRSPs and TFSAs alongside, securities (stocks, bonds etc.), and real estate ventures.

And when it comes to real estate, feel free to contact Team Kalia for investing in the Greater Toronto Area (GTA) and the Kitchener-Waterloo-Cambridge (KWC) area.

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