Three Things I've Learned About Real Estate Cash Flow

Note: This was originally written in February 2019

Cash flow is one of the most important metrics in real estate investing, as well as any other business endeavor. If your business entity does not produce positive cash flow, your options are limited at best, and at worst, you could be in serious financial trouble.

As real estate investors, we spent a lot of time trying to analyze and predict a property’s future cash flow. However, everybody does it differently. I’ve seen investors predict maintenance to be 2.5% of rent, and others predict 15%-20%. I’ve seen some predict a 2.5% vacancy factor. Not surprisingly, the real estate SELLERS (and newbies) are the ones predicting the aggressively (read: unrealistically) low expenses and high rents. Tweaking your assumptions by just a few percentage points can make a bad deal look good and vice versa.

When I first got started in real estate, I analyzed properties the best that I could but always craved some real data to back up my assumptions. This was part of my motivation to start my Portfolio Tracking - to report on the actual cash flow versus the initial predicted cash flow. This not only helps me to get better at analyzing properties and spotting deals, but allows me to pass that critical information onto others.

At the end of 2018, I took a deep dive into the data from over 36 months of owning investment real estate. In summary, I found that I was an overly optimistic newbie, especially for my first few properties. My portfolio has consistently performed at around 50% of expectations. That’s right - if I was expecting $10,000 cash flow in a year my actual came out to only $5,0000. Going forward, I will be adjusting my expectations for current property performance as well as the way I analyze future deals based on my new insights.

My three key findings are outlined below - enjoy!

Key Finding #1: The first 6-12 months of ownership sucks

The first 12 months, for nearly every property I’ve bought, have not been good. To create the graph below, I determined the GOAL and ACTUAL for each property, for each month of ownership. % to Goal was calculated as Goal divided by Actual. So, a performance of 100% means the actual cash flow matched the goal perfectly. Above 100% = good, below 100% = bad. Got it?

It’s very clear to see that in the 1-6 months and 7-12 months slots, cash flow sucks. Less than half of expectations. This is due to many reasons - getting the right tenant in a property, working through the unknown kinks and maintenance issues in a newly acquired property, or working with a new property manager are all contributing factors.

WHAT I’M DOING ABOUT IT:

I’m not adjusting my projections to expect lower performance in the first 12 months. All of the contributing factors, in my opinion, are correctable. I plan to mitigate these issues by performing formal post-rehab inspections, doing better market research on the area, raising tenant qualification standards and setting the rent RIGHT (not to low but also not too high).

Key Finding #2: The “Vacancy and Turnover” boogeyman is real, and you should be very afraid

Every real estate blog and podcast will tell you that your biggest expense is vacancy. Guess what? It’s true.

I’ve found that vacancy (and consequentially, turnover expenses) are particularly high in single family homes. The larger unit takes more time and money to turnover, and there are simply less renters capable of affording a $1200-$1500 rental - so it takes longer to find a good renter. This tempts you to lower your standards, which leads to sub-par tenants, which leads to EVICTIONS! It’s a vicious cycle.

WHAT I’M DOING ABOUT IT:

For one, I’m expecting an 8.3% (1 month out of 12) vacancy in single family homes going forward. As you can see, this is high for Indy, but low for Central PA. This is largely due to my Central PA Townhouse - which clocked in at a whopping 25% vacancy since I’ve owned it. When you remove that data point, the average moves much closer to the 8-10% range.

Also, I’m going to be shifting my focus more to multi-family acquisitions going forward. There are multiple other reasons, but vacancy is a big one. I’ve had a few vacancies in my Central PA 4-plex but they turn over and fill with a new tenant in a week or two.

Key Finding #3: Major Repairs and Capital Expenditures (CapEx) will kill your single family cash flow

All rental properties will encounter repairs here and there, but the $1,000+ expenses will affect your single family homes (SFH’s) much worse than multifamily. It’s simple math: while your SFH’s bring in $1200 in rent your multi-family is bringing in $2400 which makes it easier to ride out the big expenses.

Also, I’ve got bad news for turnkey buyers out there. Whether it’s a newly rehabbed property or not, you can still expect to encounter major repairs and CapEx. It’s still gonna happen! If you are just planning on 3% or 5% in total repairs/maintenance/CapEx, I’m telling you…it’s way too low.

WHAT I’M DOING ABOUT IT:

Previously, I applied a 5%, 7% or 10% blanket factor to account for any repairs or CapEx. Going forward, I’m going to be adding a fixed CapEx number to my expected expenses in addition to 5% for “minor repairs and maintenance”. I use a CapEx calculator to figure out what that fixed number should be, but it generally works out to about $100/month for SFH’s and smaller multi-family buildings. Below are some examples:

As you can see, again, single family takes a big hit using this approach. But my past data confirms these numbers. Simply put, I believe most investors under-estimate their total maintenance costs, especially on SFH’s.

Summary

This process has led me to the sobering realization that my current portfolio performance expectations should be lowered. After adjusting the vacancy factors and maintenance factors, and adding in a CapEx component, the total impact is seen below:

Ouch. So I’m actually about $500 further away from financial freedom than I thought.

Going forward, the obvious and natural conclusion is for me to move more towards multifamily. Not only do the vacancy and maintenance numbers support this, but I also get other benefits such as scalability. I get more bang for my buck (and my time) by doing two or three big multi-family deals rather than four or five SFH’s.

I hope you’ve learned something from these key takeaways - I know I sure did. Let me know if you have any questions in the comments or connect with me on Bigger Pockets!