What is Cash Flow Negative

Cash flow negative is a self explanatory term, implying a negative cash flow, or a condition when the income is less than expenses. It indicates higher cash outflows than the flow of income coming in. In the property sector cash flow negative refers to those property investments where the expenses incurred on the property are higher than the returns it yields. This is found in rental properties that are unable to generate sufficient income to meet maintenance and mortgage expenses and the owner has to bear the difference between the rental income and the expenses. It is a situation in which the property owner has to make provisions for funds to manage the property since the property cannot maintain itself. Having to ‘feed’ a property is the least desirable since it digs into the earnings and income of the property investor.

Reasons for cash flow negative

  • Buying property without proper research and calculations
  • Inability to find tenants which means there is no rental income
  • A sudden downswing in the property market leading to a fall in rental rates and property prices
  • Sudden maintenance expenses due to a major breakdown
  • Miscalculation of cash flow figures, by not including all the expenses
  • It can also occur while purchasing properties by outbidding the market.

How to prevent cash flow negative

Cash flow negative properties must not be bought. To avoid such investments it is important to get all calculations right. The process of calculation includes the following:

  1. Calculate the gross operating income by taking the total/gross rental income and deducting an amount for vacancy and loss of credit.
  2. Net operating income has to be calculated by subtracting operating expenses from the gross operating income.
  3. Calculate the net income percentage is net operating income divided by gross operating income.
  4. Next comes the down payment percentage (DPP), which requires the value of the current market interest rate and the gross rent multiplier (GRM) in the area. DPP = 1- (Net income percentage/GRM x I).
  5. The maximum purchase price has to be = available down payment/DPP.

With these calculations being followed a cash flow negative can be avoided. Often, rental properties are found to be cash flow negative even though the property value is appreciating. This does not help because it is still draining the property investor of his cash since the expenses have to be met. It must be remembered that cash flow negative does not reflect the profitability of a property. Even highly profitable properties may lead to a cash flow negative situation since its maintenance is higher than the flow of cash that comes in. One solution to reverse the situation is to sell the property. This of course, must be the last resort, if the rental income cannot be increased by a hike in rent.

Cash flow negative is often seen in high end properties where the rental income is lower than the maintenance expenses of the property. Though it may mean funding the gap, the returns from its sale at a later stage may compensate for it.

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