Cash flow is defined as how much rental income is left over after all expenses are paid on a rental property.
However, the issue becomes slightly complicated when you take into consideration that not every investor uses the same formula for calculating it.
Some people call cashflow the amount left over after subtracting the monthly expenses from rent. But this formula does not include random expenses you can’t anticipate—such as repairs, vacancies and big-ticket replacement items like roofs and air conditioners.
The danger with not including these items is you may start spending the cash flow you’ve been generating, and then you’ll find yourself without a way to pay for repairs or vacancies.
Others include every expense they can think of—vacancy at 10% of the gross rent (even if vacancies don’t occur very often), repairs at 10% of the gross rent (even if the lease says the tenant has to pay for repairs) and so on.
The problem with this formula is that it can make real estate investing seem unprofitable. If something doesn’t seem profitable, people won’t spend time pursuing it.
So, what is the best way to estimate cash flow?
The first thing to consider is whether to determine your cash flow on a monthly basis or a yearly basis or whether you would like to simply put “reserves” as an expense when you calculate your cash flow.
Rental property owners often measure cash flow as net cash flow, which is the amount of money left after a transaction has been finalized. Monitoring it monthly will allow an in-depth look at how your net cash flow changes on a month-to-month basis; yearly offers a bigger picture.
Accurately calculating your net cash flow will allow you to figure out your return on investment (ROI) for that property without depending on the previous owner and rental landlord to tell you this information.
How do you calculate cash flow in real estate?
Most people’s favorite subject in school wasn’t math, but it is vital to real estate investing success. Understanding how your business makes money is imperative in helping it make more. Therefore, let’s focus on an important aspect of real estate math: cash flow.
As discussed above, cash flow is generally the amount of income left after all the bills have been paid. This is often expressed as a monthly dollar amount.
For real estate investors, cash flow is the income left after paying out expenses such as the mortgage, taxes, insurance, vacancies, repairs, capital expenditures, utilities and any other expenses that affect the property.
To ensure you have a cash-flowing property, you need to perform an accurate rental property cash flow analysis.
Cash flow might seem easy to calculate but many people get it wrong. At its core, it is simple. To calculate cash flow, subtract expenses from income:
Cash Flow = Total Income – Total Expenses.
Easy enough, right? Then why do so many people get this wrong? That’s because while the equation is simple enough, the items that make up the equation are complex. Let’s take a look at both to understand them better.
While the total income might be the same as the total rent, many times it won’t be. There may be other sources of income to account for, such as application fees, late fees and laundry income.
When analyzing a property for cash flow, it’s wise to list all possible sources of income, but be conservative. It’s best to err on the side of caution and assume you’ll be getting less than you actually hope to.
After you’ve made a list of all your monthly sources of income, you’ll need to do some simple math calculations to figure out your net operating income (NOI), which is generated by your investment properties and the amount of your potential ROI, also known as a capitalization rate.
When it comes to your investment property, do everything possible to increase cash flow. Even the little things can add up. But now, let’s take a look at potential expenses you need to factor into your investment.
What is considered good cash flow?
Good cash flow is anything that puts you above $100-per-earning per unit that you own. That means aiming for $100–$200 in cash flow per unit that you buy. For a duplex, aim for $200 at a minimum. If it’s a fourplex, then $400 is the minimum. You want that to be cash flow after all the bills have been paid, including, of course, the mortgage payment.
However, there’s a caveat: the amount depends on how big the deal is. Think about it this way; if you were to invest $1 million into an investment and you’re making $100 a month, is that a good deal? No. But if you were to invest $500 and every month you made $100, that’s the better investment.
Thus, cash flow per unit or cash flow per door is a great metric. But it’s only one metric, and there’s another one to care a lot about: cash-on-cash return.
A cash-on-cash return is the percentage of your investment you make back this year in cash flow. Here’s some basic math: if you invested $1,000 and you made back $100 the whole year, that is a 10% return. Cash-on-cash return is how much money you made in profit in cash flow during the year divided by how much money you put into the deal.
So, is $100 or $200 monthly cash flow a good deal for a single-family house? That’s not the right question to ask. The right question is: How much money did you put into it? The answer to that question is the one that counts.
Other questions to ask yourself: Why are you investing? What has led to you invest in rental properties?
Do you want to retire early? Do you want a higher return on your savings? Do you want to hold property long-term for significant appreciation gains? Do you need a tax shelter?
Real estate has so much to offer, and it’s not a one-size-fits-all proposition.
Once you understand your purpose, it’s much easier to determine the kinds of property you should be buying, how much you should be spending and which strategies you should be utilizing. How cash flow is calculated is different for different people. But we can all agree it’s the money you make from a property’s rent after the expenses are paid.
Real estate cash flow killers
No one wants negative cash flow, so it helps to know what can cause it. Again, the aim is to bring in more money than you spend.
Repairs and maintenance can take a huge chunk of money out of your resources. Additionally, problems affect your tenants’ quality of life. The longer you let repairs go, the more unhappy your tenants will be and the more the repairs may cost.
Tenant turnover kills cash flow because you’ll have to do those repairs anyway plus vacancy cleanings, which can cost more than the tenant’s security deposit will cover. And if you have a property management company, it may charge you a fee to find a new tenant for you.
If your tenants are not making their rent payments, your cash flow is reduced by the amount they should have paid. Aim for long-term tenants. Encourage your tenant to pay at least half their rent, but be open and understanding to their situations, especially if a tenant misses rent only once in a while.
Real estate cash flow boosters
You want positive cash flow positive, of course, and you’ll want to make it higher than you expect, if possible. To do this, you need to bring in more money than you spend on each property each month. You can do this with the right strategies.
You can increase your cash flow by increasing rent, though you should always increase rent in line with market value and what your tenants can afford, as tenant turnover hurts your cash flow. You might upgrade a rental with new washing machine, AC unit, or other amenities that would allow you to raise the rent or you might improve rentals cosmetically.
As mentioned above, you want long-term tenants. Vacancies and turnovers mean you are paying for an empty unit and still paying for power and water and other utilities. Long-term tenants are the bread and butter of your business. Sometimes, raising the rent isn’t worth losing a good tenant.
Practice preventative maintenance to keep things from getting more expensive to repair later on. Plus, it keeps your tenants happier. You don’t want to destroy your cash flow for months on end by not taking care of repairs and necessary renovations.