You need to calculate and compare the before-tax annual and monthly cash flows of the condo over a range of bid prices. As you begin the bidding, have a firm idea of how much you can afford to pay out to “carry” the property. For example, you may be willing to pay up to $300 per month to own the rental property. So the maximum price you can bid will be a price that generates a negative monthly cash flow of $300. Prices lower than the maximum will generate lower negative cash flows, which improves your investment position.

In effect, the negative $300 cash flow represents what you are willing to pay for the privilege of owning the property, knowing that sometime in the future rental income will eventually grow and turn a negative cash flow into a positive cash flow. Of course, the big payoff is the price appreciation and principal accumulation on the property, which eventually creates substantial wealth gains.

To calculate before-tax cash flows, let’s assume that you bid the asking price, $195,000, for the condo. Your real estate agent tells you that the rental unit can earn $1,400 per month in rent, generating $16,200 in annual rental income. Now net out the expenses to finance, operate, and mange the property. With 20 percent down, you will obtain a 30-year $156,000 mortgage loan paying 7 percent interest. You will pay $12,454 in annual mortgage payments. Property taxes are estimated at $1,723 for the year. Hazard insurance (protection from fire, wind, flood, etc) costs $200 per year, and the condo fees are assumed to run $300 per month, or $3,600 for the year. Finally, you need to put $2,000 (assume about 1 percent of the bid price) aside in a reserve for repairs and maintenance (R&M) of the property. Adding the mortgage payment, property tax, insurance, condo dues (these dues are paid to the condominium association, which pays for repairs, maintenance, and improvements to the shared property, including the building, any amenities – e.g., a pool, landscaping – insurance, etc.), and repair/maintenance totals $19,977 in expenses. Netting expenses from rental revenues results in a negative annual cash flow of $3,177 and a negative monthly cash flow of $265.

The asking price of $195,000 is pretty close to what you are willing to bid, given that the $265 monthly cash outlay is a bit below your $300-per-month limit. You are now able to bid the seller’s asking price. But before you do, let’s run some other cash-flow scenarios around the $195,000 asking price to establish a range of prices that may be acceptable to you in case market conditions dictate that you bid something other than the asking price. Let’s run the cash flows for $200,000, $190,000, and $185,000. At $200,000, the monthly cash flow rises to $291; at $190,000, the cash flow drops to $238; and at $185,000, the cash flow drops further to $211.  You are now presented with the following choices:

Your Financial Limit: $300 Per Month

Bid Price                   Monthly Negative Cash Flow             Annual negative Cash Flow

$200,000                  $291                                             $3,497
$195,000                  $265                                             $3,177
$190,000                  $238                                             $2,858
$185,000                  $211                                             $2,538
If market conditions are sluggish, you, in consultation with your real estate agent, may decide to underbid by offering $185,000 or $190,000, bringing your monthly costs closer to $200. On the other hand, if conditions are tight and your real estate agent anticipates multiple bids on the property, you certainly can afford to pay $291 per month and raise your bid to $200,000. Whatever you end up bidding, if you use the above cash-flow analysis, you will be bidding intelligently. If the price of the property rises beyond your cash-flow limit, it’s probably time to move on to another property.

Of course, there are times when you’ll want to put less than 20 percent down, and other times when you’ll want to put down more than 20 percent down. If so, just plug in the new mortgage payment numbers in the above cash-flow analysis to see how sensitive the cash flows are to different loan balances. There will be times when a property’s value will work with a lower down payment and a higher mortgage amount, and there will be times when you may need to allocate more funds to a down payment in order to make the cash flows work for you.