AMA – What to do when your first rental is operating at a loss

In a recent Roofstock Academy webinar, we got an interesting question that we were unable to address during the session. The audience member asked for words of wisdom on the topic of being a beginner and your first property is operating at a loss. When is enough enough, and when should you cut your losses?     --- Transcript Before we jump into the episode, here's a quick disclaimer about our content. The Remote Real Estate Investor podcast is for informational purposes only, and is not intended as investment advice. The views, opinions and strategies of both the hosts and the guests are their own and should not be considered as guidance from Roofstock. Make sure to always run your own numbers, make your own independent decisions and seek investment advice from licensed professionals.   Michael: Hey, everyone, welcome to another episode of the Remote Real Estate Investor. I'm Michael Albaum and today I'm joined by my co-hosts…   Tom: Tom Schneider…   Emil: and Emil Shour…   Michael: and today we're gonna be tackling one of the questions we got from a webinar we did recently, as part of the Roofstock Academy recently did an AMA, which is an ask me anything, and we kind of re labeled it and ask Michael anything webinar, it was a lot of fun. If you missed it, we missed you and look forward to seeing you on the next Roofstock Academy webinar. But a question we got that we didn't have time to answer during the webinar is words of wisdom to share for the first year or two, when your rental operates at a loss. How do you know when to cut your losses?   We saw the question, we're like, man, this is a killer question. So Emil, I am just going to farm it out to you. Because I know you got really excited about it. What do you say to folks out there that have this experience or are thinking about investing in a property and this is a concern that they have?   Emil: All right, so I got excited about this because it's basically what happened with the triplex, right, I bought it in November. So the first year, November, November of 2020, most of 2021 was spent rehabbing the property, because I knew rent was under market. So you know, it's kind of in the middle of COVID, a lot of vendor issues just took us a long time to get everything done. So 2021 major loss, but now we're, we're good, we've got good tenants in there, I had to get a new property manager and we're at rents that actually, I think a little bit higher than the pro forma I had when I bought the place. So my first year too, was operating at a loss and now I feel like is going to be the true test of does the property perform. So that's my long winded way of saying, I guess it depends on how you bought it, like if you bought it turnkey, and it's operating at a loss for the first couple years. Maybe that's not the greatest time but if you bought it knowing, maybe you're gonna have to update things, you know, you knew like the roof was gonna go out sooner, some something where you knew these expenses, were going to come along, and it's fine, you know, it's going to be a loss originally. But then, hey, you're not gonna have to pay for that thing for a long time, right? You replace it and now you got a brand new age back or roof or kitchen or whatever it may be, so my answer is it depends on those factors.   Michael: Love the clear cutness, the directness, Tom, your thoughts man jumping in.   Tom: I think in making decisions, like you should try, like as much as possible to like, have it like already kind of like set up in advance. So perhaps there's like thresholds, you can kind of set on expectations? I mean, this might be a little bit like unrealistic for this scenario. So I'm gonna change my answer, I'm gonna say, I think, like, strategy wise, like, are you planning for like a longer, longer term buy and hold? Like, if that's the case, you know, the initial kind of like, upfront expenses, perhaps it's stuff that we're going to happen anyways, like, it was kind of like aging, what not. So I think it's, you know, having that kind of like, plan upfront of like, what your ultimate strategy is, like, let that inform these kind of decisions in the moment. I like that I kind of got two different answers there.   Michael: Yeah, I guess. Okay, so as a challenge to that, Tom, if I'm someone I'm buying turnkey, like Emil mentioned, and I'm planning, I plan and identify as a long term, buy and hold investor, but the first two years, just don't go my way. Don't you know, I have a couple more expenses than anticipated, so I'm operating at a loss. What should I do?   Tom: I think there's like a little more context. So like, where, where are your where's your value relative to? Or where's your, like, buy price versus the current, like, where are the values that like, could kind of go into that, I'd say probably a mistake. You need to also factor in like transaction costs, like let's say you were to like, sell and then ribeye like that should go into the calculus of like, what you're going to pay, you know, on the agent side, and just the friction of selling. So I think like that should go and count, so it's like there's, it's sort of a a lot of different colors to this painting of a decision and as detailed as you can be like of these different considerations should go into the process of you know, do you sell it or do you buy it? I mean, this is is like a great answer, because it's like kind of like asking other questions. But I feel like a lot of times like the best answers for this kind of stuff are asking additional questions that you should be kind of unearth before making that decision.   Michael: Makes a ton of sense, makes a ton of sense. Emil, I love your point about like, oh, is it turnkey or is it known that there's expenses that are going to force you to operate at a loss? Even if all of the things went well, like, you'd look at the numbers, you still put more money into it, then you got out of it? So that by definition, like it's a loss.   Emil: It's like, what are you expecting, right? Like, you know, I almost don't look at it as a loss on the renovation, it's almost part of my upfront investment. So let's say I spent 20, I probably spent about 20- 25k, repairing it, I'm not really looking at last year as a 25k loss, even though that is how it is on the like, profit and loss, whatever you want to look at it. I'm more looking at it like okay, here was my purchase price. I had add 25k, now, what is my return on that going forward?   Michael: Yep, I think that makes a ton of sense. So how do you think about like, knowing when to cut your losses? If you anticipating, hey, I'm gonna get this thing up to the triplex is a perfect example, hey, I'm gonna get this thing up to market rent, I spent the 20 25k on the renovations. I'm having trouble leasing it, I'm not getting the market rent I thought I was, do you say, well, let's cut our losses and run, I mean, how long are you going to hold on to that for?   Emil: That is a very good question and I wish I had a really good answer for that very good question. It's hard. It's like, are you in an appreciating environment, right? Like, like Tom kind of mentioned, if your property values going up, you're making money in a indirect way to potentially be able to sell later? Are you in a environment where the value is going down? Do you bought I don't even know if you're, if you're, if it's going down? Do you sell it then like or do you say, you know, right, I think in 10 years, I guess it really just depends on like, you're at this, this sucks and real estate investing, but like your gut feeling on what you should do, like, do you have a bad property manager? Do you not feel really good about the market? If you have a good property manager, and you feel really good about the market long term? You know, maybe you have more conviction and just kind of weather the storm and hold on for longer and see, like, how does it perform in years, three to five, instead of just determining you know, one or two years? I don't know.   Michael: I appreciate like that concept and I agree you to an extent, but I'm going to push back a little bit. Because I'm afraid that too many people's gut feel when you're in the thick of it is all doom and gloom and so when your renovation went over budget, and your property manager sucks, and, you know, your your property has been in foreclosure because you didn't recognize that your loan didn't get auto paid, like all these things are bearing down on you. I think it's really difficult, even if you're an appreciating killer market to see that you're carrying all these all these things on your shoulders, or on your back or wherever you're going to carry them and it's so hard to hold your head up high and see the greater good and so trusting our gut, I think can oftentimes make us lead us down the to make incorrect decisions.   Emil: Yeah, yeah, that's a good point.   Tom: Yeah, I guess to my original point, like humans are notoriously kind of can be very bad at making decisions. So like, as much as you can bake sort of a decision tree like upfront. With regards of like expectations on what kind of ranges where we hold cut bait, like, I think that's like a really interesting exercise, just so kind of in the heat of the moment, you don't have to put yourself at risk of needing to make decisions that could be like potentially a little bit emotional.   Michael: Yeah, I have this buddy and this is kinda like a stock market analogy, he set a stop loss limit on his stock at like the super low price and because he didn't want to lose any many more than that. So for anyone who doesn't know, basically, a stop loss limit is at the stock hits a certain price drops a certain price, it'll automatically show sell either all the shares or the amount of shares that you determine or $1 value determined. So that way, you kind of hedge your downside. Well, he did that and the stock price dropped one cent below, sold all his shares, and then skyrocketed back up, like way above and beyond where it was starting at the day and he was like, oh, my God, like this sucks. I'm like, yeah, dude. Like, why would you do that? That's not a that's not a thesis that I believe in. That's not something that I would ever do. I'm like, man, I'm going all the way down, if it's gonna go down, down, down into the ground, and I've done that before I wrote stocks to zero, which someone could say that probably wasn't the best decision but that's how I invest the stock market.   In any case, I think that so often we have these kind of dips like these, these lows and these highs in real estate is no different. Like, things can seem like they're really down in the dumps and they're going terribly and, and just sometimes you have to write it out and if you have the wherewithal like the mental fortitude, the wherewithal, the financial backing to be able to do that great, because the one thing we don't want to do is sell out of necessity, or have a fire sale because now we're being forced to sell. If I could recommend that anyone sell at any given time, it would be when it's ideal for them, or when they've set the kind of, they're able to dictate the terms under which they are selling. I think that puts you in a much more powerful position. I'll share an example just for my personal like, portfolio, I bought a property back in the day, it was an eight unit in the Midwest, I bought it for 305,000. The rent in place rent at the time was like 4850. So on paper, just like killer property and the expenses were just through the roof, a lot of deferred maintenance that I wasn't aware of a lot of like death by 1000 cuts type of ordeal, or just one thing after another after another after another was going wrong and the repair dollar amounts were stacking up and I'm like man, should I sell this thing should just get rid of it, I kept it and today the in place rents are like 7500 7400 over like a four or five year period, the rents are going up $3,000 a month and so now there are still some of these kind of miscellaneous erroneous pain in the butt maintenance items. But the rents have gone up so much that it really takes care of itself and so I think, Tom to use an analogy that you often say, real estate so often is going up into the right, from a value standpoint, and from a rent standpoint and so I think if you can hang on, even if you are operating at a loss for a couple of years, and it doesn't change your lifestyle, like it's not a massive, massive, massive loss hanging on can often get you through the worst of it. Now that's not to say never sell that's not to say never cut your losses and run but oftentimes, I think it can make sense to really hang on, especially just getting started because you might not know how beneficial that real estate investment could be over time.   Tom: Yeah, conservative underwriting another yeah, good takeaway and yeah, I totally agree that that's like I think like a short story, I like yours a lot better. But you know, I had a friend who bought and he like had a few issues like with, you know, rent collection were just delayed or in some, like maintenance came up and he like, kind of like panic sold and I was like, man, like, why did you do that? Like yeah, anyways, but yeah, fortitude. I like I like that and be kind of prepared for the for that kind of stuff in your underwriting, yeah.   Michael: Yeah, I guess that reminds me of like my very first property I shared it on on prior podcast episodes, but I just got absolutely hammered with my very first tenant, exiting, like leaving the property that to evict them, they smear human feces on the wall, but small claims court, like it was just such a whole ordeal and I remember, like one of the guys asked me, well, why did you keep investing and when I was too stupid to know any differently, I was like, I didn't know that it could, like that isn't the norm that those kinds of things can happen. But that's not traditional and so I think if I had stopped investing, or I had sold that property, I would have been definitely bummed because I actually just sold that property recently in a temporary one exchange, and it had doubled in value over the course of I don't know, eight, eight years, nine years, something like that. So I'm super thankful I held on to it, I'm super thankful I was too dumb and too green to know that I should have sold and so I think Tom, you made the point to think about the selling costs associated with selling the property and you're gonna pay like 6% to an agent, probably if you go through so I'm gonna pay 3%, so just for the agent costs there are often other costs and fees associated with it. So even if the property has appreciated, you still might be selling at a loss because of those fees associated with selling so I think you got to think long and hard about it versus what the potential upside is and talk to other people like talk to other investors in the area what they're seeing because like we mentioned it can be really hard to see the benefits and the upside when you're down in the in the thick of it.   Emil: Way better to like feel good about a property it's been doing really well and then you're like I think I'm ready to sell this then like you've just been you know, you've hit the hard part and you're like selling into that right before it potentially is just like going to do well for you.   Tom: This is another kind of shout out for like mentorship is like another big thing because like you know you might have like subjective getting some like subjective outside stuff like I mean I love that I can bounce this stuff off of Michael and Emil. So like getting mentors you know is up there I'd say like you know, making sure you're underwriting conservatively and then getting a second pair of eyes is really helpful.   Michael: Totally! What was, was’t it Gandalf who said like it's always darkest before the storm or like or before the day I don't know something like you're again before the storm, like I get off impression…   Emil: Yeah, really good.   Michael: With that, let's get out of here. All right, everyone that was our episode. Thanks so much for hanging in with us, especially towards the end there was kind of touch and go. If you liked the episode, please feel free to leave us a rating or review. We love answering ama type questions. So if there's something that you want to hear more about or get answered on the podcast, leave us a note in the comment section and we'll try to get to it on episode. As always, we look forward to seeing you on the next one. Happy investing. Tom: Happy investing!