What Everybody Ought to Know About Cash Flow

Calculating potential cash flow is a very important step to take as a real estate investor before you commit yourself to the long-term of owning rental properties. How much rental income will it receive for each month if the property is rented? This question relates not only to the immediate level of income but also to longer-term investment feasibility.

For example, if you expect the property to grow in value only modestly, and for very little income coming in each month, is it really worth the risk? If you believe that your income from owning rental property will not be substantial, there might be other alternatives for investing your money.

The amount of rental income you project to receive is a good indicator of whether or not the property is a valuable investment. In some areas with high demand for rental units, monthly income can be significant, perhaps even exceeding your mortgage payments and other monthly costs to produce a nice positive cash flow each month. In turn where the market is relatively soft, the viability of real estate investing makes this idea much less attractive.

So how do you calculate if a property is going to cash flow positive? It all comes down to simple math. First begin by calculating the known costs of owning a property such as insurance, property taxes, utilities, property management fees (8-12%), unforeseen maintenance costs (usually 10%), and your monthly mortgage payment. Once you have that number you basically have your monthly operating or debt expense calculated.

Next you want to calculate all the money coming in which is essentially your rental income from each unit. The best way to do this is to ask the seller’s for an APOD (Annual Property Operating Data) which is an operating statement that conforms to standard real estate practice. This should include the current rent roll for each unit and the total income coming in.

In more cases than not, the sellers I’ve dealt with usually say the tenants are paying below market value and the rents have room to increase.

If that’s the case, then why haven’t the owners already increased the rents to make more money each month? The answers I’ve heard have varied but to be honest there’s no substitute for good dependable tenants even if they’re paying $50 less each month in market value rent. A change in ownership is also a good time to adjust the rents moderately especially if you’re bringing in new tenants.

Now take this data and lay it out in an Excel spreadsheet or even on a pad of paper to begin your math. After you subtract the fixed expenses from your net income, you’ll have a good idea how much money you’ll be able to pocket each month before you even buy the property. Please note, this worksheet you are putting together is an example only. While it allows no provision for the unexpected expense or for any period of vacancy, it also excludes the potential growth in real estate property value during the year which cannot be known of course. In other words, make sure you consider all factors besides these rough numbers.

The one mistake I made from buying my first property was making sure that it would be cash flow positive each month. It wasn’t and I was paying $100 out of pocket (which didn’t seem bad at the time) but it’s still a property I was betting the farm would increase in value. That gamble did not pay off and my Las Vegas property ended up being a loss and I sold it after only two years of holding. It was an expensive lesson and one I don’t want you to make as well. Bottom-line — do not purchase an investment property unless it is break even or cash flow positive. Trust me, it’s not worth it.

19 thoughts on “What Everybody Ought to Know About Cash Flow”

  1. HometownRenter.com has the questions to ask yourself if it is better to rent or buy in your situation. Do you need the flexibility of renting? or can you afford to stay in your home for at least 5 years or longer?

    * Can you afford a 20% down payment?
    * Can you afford a monthly payment on a 30-year fixed mortgage?
    * ask your CPA … Does the tax benefit of home ownership offset a potential decline in home value?
    * Have you reduced other real estate debt before you add more on this home purchase?
    * Does a fixed monthly mortgage payment for the next 15 years outweigh the likely inflation of rents during that same time (called an inflation hedge)

    These are broad questions that can have many variations for each individual situation. However, it is a good foundation from which to start your home buying process.

    If you are in the market for a rental, visit http://www.HometownRenter.com to find your next rental home!

  2. Cash flow positive is definitely important.

    If any of the readers are new investors, I would suggest that you may want to buy a duplex or triplex and live in one of the units as your first investment. This way it’s basically an assisted mortgage payment. On a triplex, you should attempt to have two of the units pay all the payments. The third should be your bonus.

    Also, if you can’t get at least $100-$200 in positive cash flow each month, it might not be the right deal. When expenses come up to fix something, you don’t want to be totally in the hole. Also, if you have a vacancy, you’ll wish you had the extra cash as a cushion.

  3. It’s all precious lesson in property investment. I usually make completely projecting cash flow before starting developing a real estate project. The writing down cash flow will lead our daily action in operating the project. It prevent us from any losses. Principally, how to balance between cost and income.

  4. It seemed for so long that leverage was the key to real estate investing. At least for some, including the Equity Happens guys and their chapter on “Positive Cash-Flow Sucks!” I guess in the end it really should be all about cash flow and you can throw everything else out the window.

  5. You have a nice article David. Very informative and helps a lot.. I also agree with augie for the tip in buying a duplex and live in one unit and use the other unit for investment.. Thanks to both and more power.

    -david

  6. What a great break-down. As an investor you absolutely need to evaluate and understand if a potential property is worth investing in. You also need to see if it can make you money and if its worth it.

    Walt

  7. Never buy a new home from Sherwood Homes, Inc. or also known as Lane Building Corp, Inc from Omaha, NE – these people once they get their money will not stand behind their product – also the warranty company this builder uses is a thief / ProHomes from Omaha, NE. Buyer BEWARE

    Sherwood Homes, Inc. also sells under the name Lane Building Corp. – again BUYER BEWARE of this company – they will leave you in the dust once you sign on the dotted line – they will screw you and the lady that sells their homes (Nancy Woolley) is the same way…

  8. David, I must say that You have a vast idea about real estate business.
    Though its a simple calculation of mathematics but we must have to think before we can go ahead and take any steps for purchasing any house. Its a really interesting article. I really appreciate your effort. Thank you so much for sharing this type of beauty with us.
    Really Superb

  9. This article is very helpful! it is very important for a real estate investor to understand cash flow first and other things about financing. Keeping track of the money that goes in and out in your business is really essential.

    website: Bountiful Homes for Sale

  10. One needs to understand the required financing and possible cash flow that he or she can get when investing in real estate. It is best if you know every single penny that you put out and receive for this business. please visit Destin Homes for Sale if you are interested with home buying.

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