Are you accounting for the J Curve during the first year of acquiring a new investment?

Understanding this natural business trend can help you better assess your net cash flow for first-year properties.

By definition, the J Curve is an economic theory where under certain assumptions, a country's trade deficit will initially worsen after the depreciation of its currency—mainly because higher prices on imports will be greater than the reduced volume of imports.

When it comes to investment real estate, the J Curve is a symbol to conceptualize the natural dip in your investment property cash flow which should be anticipated immediately after acquisition. For any value-add property to grow, the cash flow will likely decline at some point due to repairs and maintenance and/or lack of getting consistent rent.

Expect within the first three- to six-months of a new investment that you may not generate the cash flow you anticipated. Some properties can take as long as a year to stabilize. There are a multitude of factors that cause this natural dip in profitability such as:

• Unexpected maintenance that creeps up

• Capital improvements that have to be made

• Vacancies and non-paying tenants

For many inexperienced investors, this can be intimidating. They see their newly-acquired property not showing profit within the first few months and question their purchase or even contemplate selling. While backing out to optimize immediate cash flow may seem prudent, investors should allow a grace period before giving up on a newly-acquired property. Waiting at least a year to give the property a chance to show profit before making any rash decisions. If a property is still not turning a profit after two years, it may be time to reassess the property’s ability to turn a profit.

With any property acquisition, consider the real-life factors that cause fluctuation of cash flow. Just like the stock market, fluctuation and unpredictability is part of the risk/reward. If your newly-acquired investment isn’t performing the way you anticipated, take a step back and ask yourself these four questions: 

1. Are you accounting for all of the potential factors that impact your cash flow? 

2. What can you do to improve your cash flow in a positive manner now?

3. Did you make any repairs or improvements that may have diminished cash flow?

4. Did the analytical tool you used during the property’s due diligence account for this natural dip?

The Pitfalls of Swearing by the Spreadsheet

Most investors I work with use a spreadsheet to analyze their deals and see this spreadsheet as the be-all end-all. Spreadsheets are great tools for analyzing an investment property’s anticipated cash flow. But inexperienced investors swear by their spreadsheets for every decision. While a spreadsheet can answer the analytical questions related to purchasing a property, it does not and cannot account for everything that impacts cash flow. 

Expecting that all properties will follow the J Curve to profitability is key. Consider performing additional due diligence to identify risks when assessing your purchase. Evaluate potential factors that your spreadsheet might not account for such as:

1. Sellers: A spreadsheet will tell you when a deal looks good. Whether you take on a newly-renovated property or one that needs work, a spreadsheet may cause you to assume—based on the numbers and nothing else—that the seller is selling you their best investment. Trust me, they never are. 

2. Tenants: Spreadsheets fail to account for human error. Tenants may miss payments due to a multitude of unpredictable reasons. Rent collection will waiver, especially in the first year, but may not always remain that way. 

3. Maintenance: You will never be 100% privy to a property’s maintenance needs before purchasing. There will often be necessary maintenance the seller does not disclose. In fact, there is a good chance that the sellers (and even the inspectors) won’t know the entire scope of what type of maintenance a property might truly need. A perfect example of this is sewer lines. You may purchase a well-kept, brand-new property with no obvious plumbing issues, but that doesn’t mean the city’s old sewage pipe won’t cause you a financial headache in the future. As an investor, you need to account for these unpredictable and often unforeseeable expenses—your spreadsheet won’t do it for you.

4. Capital improvements: New investors sometimes get caught up in making capital improvements that are not immediately necessary. This may not negatively impact cash flow right away, however what happens when an unpredictable and mandatory maintenance request comes in? Your money is then tied up in aesthetic improvements rather than maintenance that makes the property rentable. Remember, rentability should always be your number one concern. 

5. Policy changes or tenant relations: Just like a new boss, a new owner may not be welcomed with open arms. Immediately raising rent or not considering the impact you make on someone’s home or personal finances could end up costing you dearly. While raising rents is a natural desire of any new investment property, the manner in which you take action will make all the difference to your bottom line. Be strategic and not abrupt in any move you make.

You’ve likely heard the expression, “you have to spend money to make money.” This is true for investments, however, if your property is still not performing the way it should be, ask yourself these questions:

• Is your property under good management?

• Are people moving out after a year or less?

• How long does it take you to secure a tenant?

• Have you ignored necessary repairs because you tried to save money?

• Do you force lease renewal increases even when units are near or at market rates?

Your answers to these questions will help you better understand your cash flow situation. They will also show you the reason why you are not turning a quicker profit. Factor in unpredictability when analyzing your first-year properties and remember that the J Curve is simply that: a curve. It will eventually turn in your favor.