Hey everyone, Grant Kemp here from Creative Cashflow! Today, we’re tackling a key concept in real estate investing: going net negative upfront. This might sound technical, but it’s essential for making informed decisions in your property deals.
When you run your deals, aim to do it like a wholesale transaction. Ideally, get a property under contract, find a buyer, and have that buyer lined up before closing on the property. This way, you only own the property for a short time. However, there are scenarios where closing costs exceed the upfront income. Let’s break down this concept.
Understanding Net Negative Upfront
“Net negative upfront” means your expenses are higher than your initial income when closing a deal. These expenses include rehab costs, arrearages, and any other upfront expenses that exceed the down payment from the buyer.
My rule of thumb is to recoup these net negative amounts within 12 to 18 months of closing. This ensures a deal is still profitable in a relatively short period.
Example Scenario
Let’s say you have a property with a $150,000 After Repair Value (ARV). The property is $12,000 behind on payments and needs $15,000 in repairs. You plan to sell it with owner financing, receiving a $15,000 down payment and $1,135 monthly.
Here’s a simplified view:
- Gross Income: $15,000 down payment
- Gross Expenses:
- $12,000 arrearages
- $15,000 repairs
- $4,500 agent commission (3% of $150,000)
Total upfront expenses sum up to $31,500, leaving you $16,500 net negative upfront. You’ll need to figure out if this is acceptable by considering cash flow and other factors.
Cash Flow Considerations
In our scenario, with a monthly payment of $1,135 and an underlying lien (e.g., mortgage) of $597.39, your monthly cash flow is around $537.76. To break even on that $16,500 net negative, it will take about 31 months.
Factors to Consider
Location Quality
The property’s location plays a significant role. For instance, in the Dallas-Fort Worth area, properties in high-demand areas like Garland, Mesquite, and East Dallas might sell quickly. This reduces the risk if the initial buyer defaults, allowing for a quick resale.
Arrearage Management
Once arrearages are caught up, they don’t need catching up again if you resell the property. The first buyer basically covers this cost, easing the financial hit.
Fix-Ups
Owner-financed buyers often improve properties, reducing the likelihood of significant damages. Many are handymen by trade, investing effort into making the home better.
Equity
Properties with high equity but low cash flow might justify breaking the 12-18 month rule. Significant equity can offer financial flexibility, allowing you to leverage other deals or cover unexpected expenses.
Strategic Flexibility
Every deal has unique factors. If an underlying loan doesn’t have a due on sale clause, it reduces risk, making it a valuable component in decision-making. High equity deals, strong locations, and favorable loan terms can justify stretching the typical rules of thumb.
Creating Your Own Rules
These guidelines provide a foundation, but you should tailor them to fit your investment strategy. Understand the full picture of each deal. If you decide to break typical rules for solid reasons, go for it.
Takeaway
Mastering the concept of net negative upfront costs is crucial for successful real estate investing. By understanding and effectively managing these costs, you can make more informed decisions and ensure profitability even in challenging scenarios.
Remember to evaluate each deal holistically, considering factors like location, arrearages, fix-ups, and equity. Flexibility and strategic planning are key—don’t be afraid to adapt these guidelines to fit your unique investment strategy. With careful analysis and a thorough understanding of your deals, you can confidently navigate the complexities of real estate investing and achieve long-term success. Happy investing!
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