Questions about Good Cashflow on Rental Property?
An essential concept aspiring landlords and real estate investors need to grasp before diving into rental real estate is how to calculate rental property cash flow. After all, cash flow is the lifeline of a rental real estate business. Luckily, calculating cash flow is easier than you might think.
Alright so, a buddy of mine texted me and said, "Hey, Brandon! I've got this real estate deal I want to buy, and it should produce between $100 and $200 per month in cash flow. Is that a good deal? What do you think?"
For many, many investors, you either invest in real estate for cash flow, or you don't invest at all. Why such a strong statement? Well, that's because cash flow is such a strong force when it comes to rental properties. So strong that cash flow is essentially the main form of profit made from rental income.
What Is Cash Flow?
Real estate cash flow is the difference between the rental income and rental expenses of an investment property. With that definition, calculating cash flow is fairly straightforward:
Cash Flow = Total Rental Income – Total Rental Property Expenses
Essentially, cash flow tells a real estate investor if his/her rental property is profitable and how much money is being made. A positive cash flow property, or a positively geared property, is one that generates more in income than in expenses. Negative cash flow properties, on the other hand, have higher expenses than rental income. As a result, negative cash flow properties serve as a loss for real estate investors.
Before we dive into how much cash flow is good for rental property, let's backtrack and talk more about cash flow. Cash flow is the difference between the rental income of an investment property and its expenses. It basically tells a real estate investor if he/she is making money and how much of it is made. A positive cash flow investment property, also known as a positively geared property, is an investment property that generates more rental income than expenses. The opposite of a positively geared property is a negative cash flow property. Negative cash flow income properties generate more in expenses than rental income and thus serve as a loss for a real estate investor.
In this article, we will discuss what a good cash flow for a rental property is. In the last episode, we talked about investing for cash flow and the different ways you can do it. But what is good cash flow?
To clarify that when we discuss good cash flow for rental properties, we're talking about how much money is actually left over after we pay all of our expenses.
It really depends on the investment and the investor. A more experienced investor with more money will probably want to get a higher return on investment, whereas a new investor most likely wants to get their feet wet and learn about investment properties.
You could argue that there is nothing more investors aspire to achieve in the real estate industry than passive income. Some of the wealthiest people in the world have used real estate cash flow to acquire their fortunes. Most of them started out with small, multi-unit properties and eventually worked their way up to large commercial buildings.
Understanding real estate cash flow opens up the opportunities for real estate investors to reap the many benefits of this investment vehicle. There is a myriad of ways to get started with creating cash flow in real estate, but one of the most common is through rental properties. Continue reading to find out how you can make investments that will have your tenants paying your mortgage, all the while building up your portfolio.
What Is Cash Flow?
Cash flow represents an objective sum of money that is left over once an investor has accounted for all of their capital expenditures. In other words, an investor's cash flow is how much income they have after they have paid all of their bills; it's the money they'll hopefully be able to pocket at the end of the day. This represents their profit that they can then use to save for retirement, or re-invest in additional opportunities.
Most commonly, investors will utilize cash flow calculations to determine if a property is a good investment. If you are considering investing in rental properties, you will want to understand how cash flow is determined, as well as some of the most common expenses to account for.
How Is Cash Flow Calculated?
As previously mentioned, cash flow is the difference between the rental income of an investment property and its expenses. The standard way of calculating cash flow is:
Cash Flow = Total Rental Income – Total Expenses
To calculate the cash flow relative to the investment property, cash on cash return is used:
Cash on Cash Return = (Annual Rental Income – Expenses and Costs)/Total Cash Investment × 100%
The best tool a real estate investor can possibly use to calculate cash flow is an investment property calculator. The alternative is to use manual spreadsheets, which are laborious, to say the least.
An investment property calculator simply requires a few input variables from the investor. It then calculates cash flow immediately. The information provided by the calculator can tell you how much cash flow is good for rental property, but more on that in a little bit. For more on cash flow property analysis and investment property analysis, be sure to check out Mashvisor's investment property calculator.
How to calculate cash flow?
Calculating a rental property's cash flow is a relatively simple process:
- Determine the gross income from the property.
- Deduct all expenses relating to the property.
- Subtract any debt service relating to the property.
- The difference is the property's cash flow.
The gross rental income of a property is the total income from all sources before any expenses or mortgage payments are made. Some properties, like a single-family rental, will only have one source of income, the rental income. But certain rental properties, especially commercial property, may have additional income streams like on-site laundry, late fees, pet fees, or product sales like boxes or moving supplies.
Expenses relating to a property will differ by the property type. Commercial properties that have net leases may have fewer expenses than a residential rental property that uses a gross lease.
How much rental cash flow should you aim to earn?
Every investor has different financial goals. Some are happy with an 8% return on investment (ROI), while others seek an ROI of 15% or more. There is no magic number that is the perfect or right amount of cash flow to earn. It's common, after reviewing your financial goals, to establish a minimum cash flow per door or a minimum return requirement. When you're evaluating properties, this can help guide you in eliminating any that do not meet your standards for investing.
Just make sure you are taking into consideration the time commitment you will be putting forth in evaluating, funding, closing, and managing the property. You want to set your target cash flow high enough to make your investments worthwhile but not so high that you are unable to find properties to invest in.
What Is a Good Cash Flow on Rental Property?
Knowing how to calculate cash flow, it is apparent that positive cash flow is considered good cash flow. The higher rental property cash flow is, the more profitable. Still, can a 'good cash flow' be specifically quantified? The answer is more complicated than a simple yes or no.
The reality is that cash flow is influenced by a variety of factors in real estate. To effectively know what good cash flow on a rental property is, we need to consider the following variables.
You've probably heard it a thousand times, but the three most important things in real estate are location, location, and location. This is especially true when you're trying to find cash flow properties. Its location heavily influences a property's rental income. The same can be said for many rental property expenses, such as property taxes, interest rates, and association fees. In addition, there are other factors at play in each location. An area's short-term rental legislation, for instance, can restrict Airbnb cash flow due to various permit requirements and other rules. If the area has rent control laws, the rental income potential may be limited. Local economic trends dictate demand for traditional rentals (which can greatly affect rental income). All of this will affect the cash flow.
Property Type and Price
What is considered a good cash flow also depends on the property type. Different property types can have different potentials for earning rental income based on the number of units that can be occupied at one time. Multi-family rental properties, for instance, have more rental units than a single-family property. As a result, multi-family properties generally have a higher potential for cash flow than their SFR counterparts.
The price of the property also plays a role. More expensive properties usually fetch a higher cash flow than less expensive rental property investments. This is because you can usually charge a higher rental rate for a variety of reasons whether it's additional amenities, more space, or even a better neighbourhood.
Like property type, rental investment strategies also influence what good cash flow on a rental property is. An Airbnb rental strategy, for example, generally yields more cash flow than traditional rentals.
Rental Property Financing
Lastly is rental property financing. Paying in cash or with a mortgage will significantly change cash flow. And if you do opt to use a mortgage, your interest rate and what you pay in terms of monthly mortgage payments can also affect how much money you make every month. To better understand the full effect of your financing method, you should use an investment property cash flow calculator, but more on that later!
Determining Cash Flow
Investors well-versed in determining cash flow will find it much easier to uncover a rental property's true potential. That said, you don't need to be an expert to calculate rental property cash flow on your own; the process is relatively simple as long as you have the right data at your disposal. In fact, calculating cash flow is as simple as subtracting all of your expenses from all of your income. Since income and expenses are generalizations at the very best, however, here's a more detailed explanation of how to calculate a home's cash flow potential:
- Add All Of The Income: To get things started, identify how much you expect to make over the course of a year in rental income. Carefully evaluate local comps (comparable properties) in your market and determine how much you could potentially rent the property out for each month. Comps will be the best way to come up with a rental income number in a given area, as long as the comps were pulled correctly. You can also speak with local Realtors or property management companies to get an estimate of what your subject property would rent for. Take that monthly number and multiply it by 12 to determine the annual income.
- Subtract All Of The Expenses: Next, take the rental income and subtract any expenses you expect to incur. If you are using the rental income to pay the mortgage on the rental property, include that here. Be sure to include everything from property and income taxes to maintenance costs and anything else that'll deduct from your bottom line. The resulting number will be the cash flow of the subject property.
While this equation is relatively simple, it only works if you have done your due diligence. Saying you are going to subtract expenses is one thing; actually doing so accurately is another. Countless things must be accounted for, not the least of which is required to get the job done correctly, and in a way that actually benefits the investor.
The Most Common Rental Property Cash Flow Detractors
One of the most important steps when calculating cash flow is to estimate the expenses that your investment will have. To accurately break down expenses, you need to be aware of every potential cost. Overlooking even one of these items can change the bottom line cash flow of your rental property.
Below are some of the most commonly ignored monthly rental property expenses:
- Utilities: Most potential rental property owners are aware of the basic utilities that come with buying a home. A rental property is a little different in that you may only be on the hook for a few of them. Before you can make your calculations, you should research your market to discover which ones are standard to pay for. Cable, electric, and oil-based heating should be your tenant's responsibility. However, it is not uncommon for landlords to pay the water & sewer bills. Depending on the market, you may have to make some concessions and include some utilities to get top dollar for your rent.
- Property management: Many new investors start by managing their own properties. This works until they find that they either don't have the time, desire, or skills necessary to do the job right. Whether you are considering property management now or not, you need to factor this into your cash flow estimate. The typical fee ranges around 10% of the monthly rents received. By adding this into your projections, it allows you to use property management if you see your business growing and you can no longer manage properties yourself.
- Repairs: Even if you have the best tenants, there will always be minor items that need your attention. Little things like toilet clogs, appliance repair, or broken garbage disposal happen from time to time. It is best practice to save one month of rental income and use that as your reserve fund for potential repairs.
- Seasonal expenses: This is perhaps the most commonly overlooked area of expenses. Different markets have different seasonal costs. In areas that are impacted by snow, you should come up with a snow removal budget. You also should factor in lawn maintenance and preventative updates to your fireplace, central air unit, and furnace. Lastly, it is essential to add to any marketing cost you have to acquire new tenants. Even though these will not be every month, they need to be added to your annual expense calculations.
How Much Is Cash Flow Good For Rental Property?
To classify a good cash flow is to submit to a subjective opinion; what one investor may consider a good cash flow, another may completely ignore. Good cash flow is nothing, if not situational. However, one thing is for sure: all investors aim for positive cash flow. Positive cash flow suggests the potential for profits. In fact, the more positive cash flow an investment property has, the better.
With that in mind, there is at least a percentage most investors should aim to achieve with their real estate investments. While returns will differ from exit strategy to exit strategy, most investors seek somewhere in the neighbourhood of a six to 12 percent return.
Generating income from cash flow on your rental properties can be a strategic investment. In addition to cash flow, you may also be able to pay down any mortgages and generate equity. Remember, when it comes to real estate cash flow, calculating your rental property income and expenses accurately will be your key to success.
If you're getting a 5% yield on your property, then most likely after you pay the expenses and interest it's going to be a negatively geared property.
Anything around 7% to 8% is often going to be in the neutral-positive zone, depending on how expensive the property is. On the lower end, when the properties are around $100,000, the percentage range might not make it positive cash flow. However, as you get higher up to $500,000 or more than being at 7% or 8% is probably going to generate a positive cash flow for you.
Yields over 9% are often going to be favourable cash flow properties as long as you have a tenant and are receiving rental income without having to pay for massive fees and expenses.
Overall always be aware of what your expenses are going to be since this is a rough guide. You can also use a free gross rental yield calculator by searching for "gross rental yield calculator" and you can find out what the rental yield is that way.