Rental Property Cash Flow Explained

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Key Takeaways

• Even a simple understanding of the cash flow basics can improve an investor’s ability to realize profits.
• There is perhaps one benefit buy and hold investors covet more so than any other: rental property cash flow.
• Real estate cash flow is a great goal to strive for if you want to realize a passive business strategy.

You could argue that there is nothing more investors aspire to achieve in the real estate industry than passive income. Some of the wealthiest people in the world have used real estate cash flow to acquire their fortunes. Most of them started out with small, multi-unit properties and eventually worked their way up to large commercial buildings.

Understanding real estate cash flow opens up the opportunities for real estate investors to reap the many benefits of this investment vehicle. There is a myriad of ways to get started with creating cash flow in real estate, but one of the most common is through rental properties. Continue reading to find out how you can make investments that will have your tenants paying your mortgage, all the while building up your portfolio.

What Is Cash Flow?

Cash flow represents an objective sum of money that is left over once an investor has accounted for all of their capital expenditures. In other words, an investor’s cash flow is how much income they have after they have paid all of their bills; it’s the money they’ll hopefully be able to pocket at the end of the day. This represents their profit that they can then use to save for retirement, or re-invest in additional opportunities.

Most commonly, investors will utilize cash flow calculations to determine if a property is a good investment. If you are considering investing in rental properties, you will want to understand how cash flow is determined, as well as some of the most common expenses to account for.

Determining Cash Flow

Investors well-versed in determining cash flow will find it much easier to uncover a rental property’s true potential. That said, you don’t need to be an expert to calculate rental property cash flow on your own; the process is relatively simple as long as you have the right data at your disposal. In fact, calculating cash flow is as simple as subtracting all of your expenses from all of your income. Since income and expenses are generalizations at the very best, however, here’s a more detailed explanation of how to calculate a home’s cash flow potential:

• Add All Of The Income: To get things started, identify how much you expect to make over the course of a year in rental income. Carefully evaluate local comps (comparable properties) in your market and determine how much you could potentially rent the property out for each month. Comps will be the best way to come up with a rental income number in a given area, as long as the comps were pulled correctly. You can also speak with local Realtors or property management companies to get an estimate of what your subject property would rent for. Take that monthly number and multiply it by 12 to determine the annual income.
• Subtract All Of The Expenses: Next, take the rental income and subtract any expenses you expect to incur. If you are using the rental income to pay the mortgage on the rental property, include that here. Be sure to include everything from property and income taxes to maintenance costs and anything else that’ll deduct from your bottom line. The resulting number will be the cash flow of the subject property.

While this equation is relatively simple, it only works if you have done your due diligence. Saying you are going to subtract expenses is one thing; actually doing so accurately is another. There are countless things that must be accounted for, not the least of which are required to get the job done correctly, and in a way that actually benefits the investor.

The Most Common Rental Property Cash Flow Detractors

One of the most important steps when calculating cash flow is to estimate the expenses that your investment will have. To accurately break down expenses, you need to be aware of every potential cost. Overlooking even one of these items can change the bottom line cash flow of your rental property.

Below are some of the most commonly ignored monthly rental property expenses:

• Utilities: Most potential rental property owners are aware of the basic utilities that come with buying a home. A rental property is a little different in that you may only be on the hook for a few of them. Before you can make your calculations, you should research your market to discover which ones are standard to pay for. Cable, electric, and oil-based heating should be your tenant’s responsibility. However, it is not uncommon for landlords to pay the water & sewer bills. Depending on the market, you may have to make some concessions and include some utilities to get top dollar for your rent.
• Property management: Many new investors start by managing their own properties. This works until they find that they either don’t have the time, desire, or skills necessary to do the job right. Whether you are considering property management now or not, you need to factor this into your cash flow estimate. The typical fee ranges around 10% of the monthly rents received. By adding this into your projections, it allows you to use property management if you see your business grow and you can no longer manage properties yourself.
• Repairs: Even if you have the best tenants, there will always be minor items that need your attention. Little things like toilet clogs, appliance repair, or broken garbage disposal happen from time to time. It is best practice to save one month of rental income and use that as your reserve fund for potential repairs.
• Seasonal expenses: This is perhaps the most commonly overlooked area of expenses. Different markets have different seasonal expenses. In areas that are impacted by snow, you should come up with a snow removal budget. You also should factor in lawn maintenance and preventative updates to your fireplace, central air unit, and furnace. Lastly, it is important to add in any marketing cost you have to acquire new tenants. Even though these will not be every month, they need to be added to your annual expense calculations.

How Much Cash Flow Is Good For Rental Property?

To classify a good cash flow is to submit to a subjective opinion; what one investor may consider good cash flow, another may completely ignore. Good cash flow is nothing, if not situational. However, one thing is for certain: all investors aim for positive cash flow. Positive cash flow suggests the potential for profits. In fact, the more positive cash flow an investment property has, the better.

With that in mind, there is at least a percentage most investors should aim to achieve with their real estate investments. While returns will differ from exit strategy to exit strategy, most investors seek somewhere in the neighborhood of a six to 12 percent return.

Summary

Generating income from cash flow on your rental properties can be a strategic investment. In addition to cash flow, you may also be able to pay down any mortgages and generate equity. Remember, when it comes to real estate cash flow, calculating your rental property income and expenses accurately will be your key to success.

Are you fully aware of the mechanisms driving cash flow in rental properties? Is your rental properties cash flow positive? Please feel free to leave a comment on your own cash flow experiences.