Generating a reasonable passive income is one of the primary goals of many real estate investors, and you can achieve that by determining cash flow. So, you need to understand how you can compute cash flow so that you can pick the best rental assets to add to your portfolio. Also, you need to look for hidden opportunities that other investors can easily miss.
In this article, you’ll learn how to calculate a rental property cash flow, get some tips on finding lucrative properties, and know why good cash flow for other investors might not be fit for you.
What Is Cash Flow?
Rental properties usually generate two kinds of cash flow:
- Net cash flow
- Gross cash flow
Gross cash flow is any amount that you collect from rentals and other received payments, like late fees, application fees, and appliance rentals from tenants. On the other hand, net cash flow is the amount you have after deducting all your dues and expenses from the gross cash flow.
Preferably, the net cash flow of your rental property is always positive. But it can also become negative if your expenses exceed the income generated by your real estate asset. You can have a negative cash flow rental property for a few reasons, such as prolonged periods of vacancy, paying more for maintenance and repairs, and utilizing too much leverage when you avail of financing options.
Calculating Cash Flow
You can determine the cash flow of your rental property by following these steps:
- Get the gross cash flow by combining all of your rental income and other payments you receive from your property.
- Subtract your total operating expenses and capital expenditures (CapEx).
- Deduct the mortgage payments for your rental property if you availed of financing to purchase it.
The remaining balance is your net cash flow. Now, let’s look at a rental property cash flow example using made-up figures of a fictional real estate asset.
Rental income – $7,500
Vacancy factor – $400
So, your gross cash flow is $7,900.
Property taxes – $900
Property management costs – $600
Leasing fees – $200
Insurance – $350
Maintenance and repair costs – $800
So, your total operating expense is $2,850.
Your net operating income (NOI) can be determined by deducting the total operating expense from the gross cash flow. So, it is $5,050.
However, you still need to deduct the following expenses if you have them.
Capital expenditures (CapEx) – $500
Mortgage payment – $0
Now, your rental property’s final net cash flow is $4,550.
However, you must remember that the performance of a cash flow investment property won’t be consistent in several months or years. For instance, your leasing fees can be reduced by maintaining a low tenant turnover. Also, the amount you’re spending for maintenance and repairs can be lessened by regular preventative maintenance. Some of these procedures include servicing HVAC units or furnaces to avoid paying for unforeseen, expensive fees.
How Much Cash Flow Is Good?
Alt-text: a red Supreme cash gun spewing dollar bills
The quick answer to the perennial question, “how much cash flow is good for rental property,” is that any amount of positive cash flow is good. However, the bigger it is, the better. In truth, the thing that makes cash flow “good” can be different for every investor, and it is highly subjective.
Some investors tend to look for a minimum return on investment (ROI), while others prefer a property that creates a stable net cash flow that can sustainably meet cash-on-cash yields.
Return on investment (ROI)
The ROI can gauge how good your investment capital is being used in your rental property. If you want to determine this number for your asset, the formula for ROI compares the amount you paid for the property and your net profit:
ROI = net cash flow / property cost
$20,000 yearly net cash flow / $150,000 property cost = 0.08 or 8% ROI
There’s a general rule that most investors follow, and it states that you need to look for an ROI with a minimum of 8%. But this is based on the investment strategy you use, and some people are okay with netting a 6% return. Still, some are keen on finding the perfect “cash cow” rental property and prefer to snap up those with ROIs exceeding 12%.
An alternative way of knowing how much rental property cash flow is suitable for your portfolio is by assessing the cash-on-cash return of your investment. This factor compares the net profit generated by your rental property with the amount you invested into the rental property (instead of the overall property cost):
Cash-on-cash = net cash flow / amount invested
So, if you made a down payment of around $30,000 on a rental property that makes a net cash flow of around $5,000 annually (after covering for all of the bills and mortgage), your cash-on-cash return would turn out to be:
$5,000 net cash flow / $30,000 from your down payment = 0.167 or 16.7%
Also, cash-on-cash return is a perfect estimation that you can utilize if you’re going to invest in value-add rental properties.
After that, you can acquire a rental property that requires another $10,000 for further upgrades. When the improvements are made, because of increased gross rents due to your improvements, your net cash flow reaches $6,000. Your latest cash-on-cash return would now be:
$6,000 net cash flow / $40,000 amount invested ($30,000 from DP and $10,000 from repairs) = 0.15 or 15%
Same with ROI, you can get a “good” cash-on-cash return, but it varies in every situation. Many cash flow investors usually aim for a minimum return of around 10% on the investments they make.
Your rental property cash flow is the lifeblood of your investment portfolio. Luckily, it’s pretty easy to determine with just three easy steps than other more complicated financial procedures. In many real estate markets currently, it’s quite challenging to find the best asset with a stable cash flow.
But if you get lucky, you’ll get the satisfaction of making enough cash flow to cover the property’s operating expenses while creating sustainable passive income. So, if you’re one of these people, you’re one step closer to building your long-term wealth and achieving financial freedom!