Buying a Rental Property That Will Generate Cash

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Buying a Rental Property
That Will Generate Cash

By June Fletcher

Question: Three years ago, I bought eight single-family rental properties. They have appreciated, but I have negative monthly cash flow. How can I get a no- or little-money down deal on a multifamily unit with positive cash flow?

-- Hisashi Nagashima, Schaumburg, Ill.

Hisashi: Before you buy any property, ask yourself, "What's more important, appreciation or positive cash flow?" Single-family homes in the most desirable neighborhoods may appreciate quickly, but because their carrying costs are high, they rarely generate the sort of income needed for positive cash flow. Multifamily units that bring in the bucks each month are likely to be in more modest parts of town and aren't likely to show as great appreciation. You can't expect to dine on T-bone steaks when you're raising roosters.

Then, check track sales records, which you can get from the listing agent or on Web sites like Domaina.com. If appreciation is your goal, then only look at homes that have appreciated well in the past, bearing in mind that the market is cooling. If you want guaranteed positive cash flow, insist that your real-estate agent show you income-producing properties with favorable balance sheets and with established, reputable tenants. Make sure that you see the income and expense statements for these properties for at least the previous two years. Pay attention to what's been done in capital improvements, and what you can expect in terms of maintenance and repair costs, association fees and other expenses.

Most investors want positive cash flow and stable tenants, so don't rush your search. Don't believe those self-appointed gurus who say you can waltz into any town and find a terrific deal within a day without putting down any of your own money. If it were that easy, don't you think they'd be doing these deals themselves instead of traveling from one dingy hotel ballroom to the next, touting their "sure-fire" systems? (Also, remember that plenty of amateur investors have taken these get-rich-quick courses, and are already hounding the relatively few desperate sellers who are the most open to no-money-down schemes -- those going through divorce, on the brink of bankruptcy, or who inherited rental property they don't want to manage.)

Once you locate a good income-producing property, consider acquiring it through a tax-deferred IRS 1031 exchange with one of your single-family houses, using a real-estate lawyer or a certified public accountant as an intermediary. Although the process is a bit complicated and only applies to investment properties, the payoff is that you will be able to sell the single-family home to anyone you want without having to pay any capital gains tax on the appreciated value. For a thorough explanation of tax-deferred exchanges, pick up "How a Second Home Can Be Your Best Investment" by Tom Kelly and John Tuccillo (McGraw-Hill, 2004). Also, keep in mind that the positive cash flow that your properties generate is taxable, though it may be sheltered by depreciation. "Real Estate Investing from A to Z" by William H. Pivar (McGraw-Hill, 2004) explains the subject clearly.

To learn more about 1031 exchanges, read the article: "Avoid These Errors in 1031 Exchanges."

-- June Fletcher is a staff reporter at The Wall Street Journal and the author of "House Poor" (Harper Collins, 2005). Her "House Talk" column appears most Fridays on RealEstateJournal.com. Email your questions about the residential real-estate market. Please include your name, city and state. If you don't want your name used in our column, please indicate that. Due to volume of mail received, we regret that we cannot answer every question.

Email your comments to rjeditor@dowjones.com.

-- December 09, 2005