Investors before diving into the real estate industry should know how to calculate rental property cash flow. As cash flow is the lifeline of the rental real estate business. Through this blog, you are going to acquire a good idea about investment properties with good cash flow. We will make you understand how to use a rental property cash flow calculator to maximize positive cash flow. And thus in this way you will become a smarter businessman well equipped to combat the shortfalls and make maximum positive cash flow within your investment.
What is Cash Flow?
Cash Flow is the difference between a property’s income and expenses including debts. It represents the amount of money that remains back after all capital expenditures are made. It is the vitality of a real estate investing business. It is used in income-generating properties such as an apartment complex, single-family rental, duplex, or commercial building. The property has positive cash flow if the income is more than expenses and financing costs, it can have negative cash flow if the expenses and financing costs exceed the income. More cash flow determines better returns and more income for the investors.
Rental Property Cash Flow Calculator
The calculation of Cash Flow is easy and simple. It is explained stepwise below:-
Cash Flow = Gross Income – Property Expenses
- Firstly you have to calculate the gross income from the property by identifying the expected rental income over a year. The additional income streams such as service fees or coin-operated laundry and vending machines should be included.
- Next you have to subtract all property expenses and debts related to the investment property. This step includes all the deducted amount from your bottom line of the income such as mortgage payments and repair costs.
- The difference number is the property’s cash flow. The more accurate data you can collect, the more precise your cash flow calculation will be.
The gross rental income of a property is the net income from all sources before any expenses or mortgage payments are made. And the expenses related to property differ with the type of property. Commercial properties having a net lease have fewer expenses than a rental real estate property that uses a gross lease. The expenses include vacancy rates, property taxes, property insurance, property management, utility expenses(water, electric gas, trash, etc), business license, advertising, and other miscellaneous fees.
Subtracting the expenses from the gross income provides the net operating income (NOI) of the property. NOI does not bother about the debt service. It’s the cash flow the property implements if there are no financing expenses. But if there is debt service then it has to be subtracted after the expenses to provide the property’s cash flow.
Rental property cash flow analysis
When the property expenses are not available and you want to analyze the profitability of the investment to pursue further due diligence, you can use the 1% rule. The 1% rule in rental real estate is a formula to determine whether the property is going to have a positive cash flow or negative.
The rule states that the property’s rental rate should be a minimum of 1% of the purchase price. For example, if the property is for sale for $500,000 then it should provide a rental income of $5,000 monthly. But if the rental income is $4,000 then it wouldn’t satisfy the rule. The increase in rental income in relation to the purchase price determines better return.
The 1% rule is a general thumb rule. In various real estate markets, this rule does not go forth. If the rental property of the real estate is expensive if the state implies higher property taxes if the area requires extra insurance for flood or any other natural calamities or has deferred maintenance then those property’s 1% purchase price may not provide positive cash flow. This rule is not the foremost cash flow analysis; rather it is a quick tool to check it and make a decision of moving further.
This is the formula used to size up the property’s cash flow quickly. If a property makes a cut at the opening stage then also you should mind your due diligence and go through the analysis of the deal thoroughly.
Rental property cash flow detractors
Before calculating its expenses should be estimated for the investment. We must go through a thorough examination of the rental property expenses in order to get an accurate value. Even if one financial item is overlooked then it will hamper the bottom line cash flow of your investment property. Here are the common detractors which we should be aware of;
- Utilities – As a rental property owner you must provide some basic utilities to your tenants. Some essential covered utilities are water, sewer, and trash provided by the owner while others are provided by the tenants. Depending on the market you might offer extra utilities to make yourself competitive and to get top dollar for your rental property.
- Property Management – Mostly new investors manage their property by themselves. They do it until they face any problem such as lack of time, desire or skills. Whether you are managing by yourselves or not, you need to factor this into the estimation of cash flow. Generally the fee ranges from 10% of the monthly rents received. By adding this into your projection it allows you to use property management if you wish and want to see your business growing.
- Maintenance and Repairs – Regarding maintenance and repair an amount of money is incurred on a monthly basis. As the things need to be maintained throughout the calendar year. So it is best to save one month of rental income and use that as your reserve funds for potential repairs. The repairs may include plumbing, fixing broken appliances etc. There can also be seasonal expenses such as snow removal, gardening, window cleaning etc. And finally you must remember to budget for larger expenses such as remodelling, renovations, expansions, repairing cracked pavement or replacing rooftop.
- Property Operational Costs – Last but not the least leave no stone unturned to get the accurate return of the invested property. Keep an eye over the factors coming occasionally such as costs of vacancies and marketing. Remember about the annual expenses which include property taxes and premium insurances.
How much rental cash flow is good for a rental property?
To classify a good cash flow generally depends on investors. Each and every investor has a specific goal. Some investors are satisfied with an 8% return and others want to seek a return of 15%. There is no fixed amount of return or amount of it to earn. It is decided after verifying the financial goals. But one important thing which every investor should look for is positive cash flow. Since a positive value indicates a better return. With everything in mind, the investors should aim to achieve a percentage with their real estate investments. While returns differ from exit strategy to exit strategy, investors seek mostly a return of 6 to 12 percent.
Benefits of positive cash flow of rental property
Experienced investors are aware of maximizing their return by increasing their income and minimizing the expenses to the maximum possibilities. While investing in a new deal investors always use a cash flow calculator to ensure the investment is worthwhile.
A positive cash flow is important for the career of a real estate investor. You can also reinvest it into your business as per your requirements. You can invest a part of the whole of it to improve your existing properties, pay off mortgages, or in purchasing additional properties. You can also improve your personal finance with the cash flow by putting it towards retirement plans. Henceforth positive cash flow of rental property tends to be beneficial for the investors.
Obtaining a positive cash flow is one of the best practices in real estate investment. If you have sufficient of it then it keeps your business in a floating stage. Investing in rental properties having positive value must be the aim of every investor. But it’s not easy to find a positive cash-flowing property each and every time. So if you have the knowledge of calculating rental property cash flow you can sit peacefully knowing that you are investing in a worthwhile property and thus increasing the income and livelihood.