What is cash flow in real estate | Real estate cash flow calculator | Rental property and real estate cash flow detractors | How to generate positive cash flow in real estate | Benefits of positive cash flow
One could argue that passive income is one of the most appealing opportunities in real estate. If we look at some of the wealthiest individuals in the world, many of them have taken advantage of cash flow from real estate investments to amass their wealth.
If you’re not a real estate mogul yet, don’t worry. Many successful investors came from humble beginnings. They started small with single and multi-unit properties before working their way up to commercial buildings. However, they could do this because they understood the importance of cash flow and implementing tactics to maximize it. In this guide, we’ll explain how to use a cash flow calculator to maximize positive cash flow within your real estate investments. That way, you’ll be better equipped to combat shortfalls and make smarter business decisions regarding rental properties.
What Is Cash Flow in Real Estate?
In real estate, cash flow represents the amount of money that remains after all capital expenditures have been made. In other words, cash flow represents the profit that an investor can pocket after they’ve paid all their bills. Investors often direct cash flow back into their business to bolster their cash reserves, pay off mortgages faster, or buy additional properties.
Cash flow is, therefore, the vitality of a real estate investing business. Seasoned investors make a point of performing cash flow calculations to determine if a property would perform well. They’ll almost always reject a potential property if the cash flow projections are below a certain threshold.
How Much Cash Flow Is Good For a Rental Property?
All investors aim to earn a positive cash flow. They won’t consider buying a rental property if the projected cash flow is negative. No one in their right mind wants to lose money on an investment.
However, there is no strict answer as to what substantiates a “good” level of cash flow. It’s subjective, can change from one investor to the next, and is circumstantial based on experience and the local rental market. As a rental property owner, you’ll always want to make sure that the cash flow is enough such that the investment is profitable.
A good rule of thumb is the 1 percent rule. This is a formula that rental property investors use to size up a property’s cash flow quickly. The rule stipulates that the property’s total rental income should be 1 percent of the purchase price at a minimum. Anything under this threshold should be rejected. Rental properties with a higher income relative to the purchase price will earn you more cash flow.
Note that the 1 rule is only to be used as a general rule of thumb. Even if a property makes a cut initially, you should still mind your due diligence and run a thorough deal analysis. However, it’s a great tool to use to sort through several listings more quickly.
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Real Estate Cash Flow Calculator
Again, the 1 percent rule can be used as a quick indicator of a property’s profitability. Once you find a rental property that satisfies this initial requirement, it’s time to run it through the cash flow calculator.
Doing so will help you get a more accurate depiction of your profit. The calculator is a simple formula. Once you’ve gathered all the necessary data, it’s fairly simple to calculate. Below is the real estate cash flow calculator, followed by an explanation for each step:
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Calculate the gross income from the property (rent payments, etc.): First, identify how much you expect to make over a year in rental income (monthly rental payments multiplied by 12). Don’t forget to include additional income streams, such as service fees or coin-operated laundry and vending machines.
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Subtract all property expenses and any debts related to the property: Next, subtract all property expenses and related debts from the gross income. This step will require you to tally up everything that will be deducted from your bottom line, including things like mortgage payments and repair costs. We’ll provide a further explanation on various rental property expenses shortly.
The resulting number from the two steps above is your cash flow. Running through this exercise will help you realize that you’ll have to look at numerous figures affecting your property’s operational costs. The more accurate data you can collect, the more precise your cash flow calculation will be. This tends to be the trickier part. Making the cash flow calculation is easy, especially when using an online rental property calculator like this one.
Rental Property and Real Estate Cash Flow Detractors
Profits are easily overestimated because hidden or unexpected expenses can pop up. We recommend a meticulous examination of rental property expenses to get as accurate a cash flow estimation as possible. Overlooking even one financial item will shrink your bottom line.
Below we’ve gathered common cash flow detractors that you should be aware of:
Utility Costs
As a rental property owner, you have the responsibility to provide basic utilities for your tenants. The cost of these utilities varies by usage, but you can call each utility company to find out the standard rates. Most landlords will cover essential utilities such as water, sewer, and trash, while tenants must pay the rest. However, you might offer to cover additional utilities to make yourself more competitive and get top dollar from your tenants.
Property Management
Hiring a property management property is optional. If you’re just getting into rental property investing, you might try managing a property yourself. This is especially convenient if you’ve invested in a multiplex and live in one of the units yourself.
However, you may discover that hiring a property manager is worth the cost. They can take care of day-to-day operations that would otherwise eat up your time and energy. That way, you can use your free time to grow your rental property business. Property managers typically charge roughly 10 percent of your total rental income. Their skillset is often worth the investment, especially when it means you don’t have to deal with responsibilities like collecting rent, marketing available units, screening potential tenants, and overseeing repairs and maintenance.
Maintenance and Repairs
Speaking of maintenance and repairs, these costs will recur on a monthly basis even if you have the best tenants. This is because things tend to need repair and upkeep throughout the calendar year. As your property and various appliances get older, costs may increase.
On a more regular basis, you can expect to invest money into repairing plumbing or fixing broken appliances. There will also be seasonal expenses such as snow removal, gardening, and window cleaning. Finally, don’t forget to budget for larger expenses such as remodels, expansions, repairing cracked pavement, or replacing roofing. It’s highly recommended that you set aside a percentage of your monthly rental income for these larger expenses when they come up. Although this should be accounted for as a monthly expense, you’ll thank yourself when a catastrophic event happens, and it won’t hurt your bottom line.
Property Operational Costs
Last but not least, leave no stone unturned to accurately sum up all of your operational costs. Keep a lookout for things that only come up occasionally, such as the cost of vacancies and marketing. Don’t forget about annual expenses, including property taxes and insurance premiums.
How to Generate Positive Cash Flow in Real Estate
Now that we’ve covered the possible line items that could detract from your cash flow, it’s time to discuss how to maximize it. The formula indicates that an investor needs their rental property income to exceed their expenses. Otherwise, their cash flow will either be zero or negative. To generate a positive cash flow, your main objective should be increasing your income while minimizing expenses as much as possible.
Here are some ideas that can be implemented to help create more financial abundance for your rental property business:
Mindful Rent Pricing
Setting the right rental prices is a balancing act. You’ll want to charge the highest rental rates you can without turning off potential tenants. If your rental property is located in a competitive neighborhood, or a unit opens up when demand is high, you might get away with charging more for rent than normal. On the other hand, you might be forced to drop your prices a bit if you’re not getting any bites. This demonstrates why it’s so important to keep a consistent hand on your local rental market’s pulse.
Increase Rental Income
You can also boost your rental income by raising your rental rates. It’s common practice for landlords to introduce an annual rent hike. However, be careful to keep price increases modest, or you might be facing a mass exodus from your tenants.
Raising your rent prices is also justifiable if you’ve invested in upgrades and renovations. You’ll be able to attract higher-paying tenants by offering premium features and amenities.
Include Additional Income Streams
Last but not least, find additional streams of income that can boost your bottom line. A great example is pet rent. Landlords seldom allow pets, especially in apartment buildings. This is because pets increase the risk of damage. However, this creates an opportunity. Tenants are willing to pay more, both in rent and additional pet rent, to keep their pets. This is especially true when they have a hard time finding landlords that allow pets. You can protect yourself from the cost of mitigating pet damage by charging a refundable or non-refundable pet deposit.
Other examples of additional revenue include optional fees for storage, laundry facilities, gym and recreation center, and parking. However, be careful not to nickel and dime your tenants on every feature, or they may get turned off. It’s usually best to charge extra for features and amenities that a tenant could live without if they wanted to save on costs.
Benefits of Positive Cash Flow
Seasoned investors know how to maximize their cash flow by increasing their income while minimizing expenses as much as possible. When purchasing a new investment property, they always use a cash flow calculator to ensure the investment is worthwhile.
It should go without saying that a positive cash flow is beneficial to your livelihood and your career as a real estate investor. Cash flow can be reinvested into your business. For example, you can use it to improve your existing properties, pay off mortgages faster, or purchase additional properties. You can also use your cash flow to improve your personal finances, such as putting it towards retirement or pursuing other investing forms.
Summary
Maintaining a positive cash flow is just one of many best real estate investment practices. As you gain more experience, you’ll learn that there are numerous strategies you can incorporate to mind your due diligence and operate your investing business smoothly. Luckily, investors also have handy tricks and shortcuts available to make some processes easier. The cash flow calculator is just one of them. Make sure to stay educated so that you can build a thriving real estate business.
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