Do you want to make money by investing in rental properties? Then you must first learn the importance of cash flow. Most beginner real estate investors invest in rental properties for cash flow because it is essentially the shortcut to building your wealth in real estate. But how much cash flow is good for rental property? And how can you spot positive cash flow properties? Keep on reading this article for answers.
Cash Flow: What Does It Mean in Real Estate Investing?
Simply put, cash flow is the difference between the gross rental income of a rental property and its expenses. Expenses include financing costs (mortgage payments), taxes and property insurance, maintenance costs, and other miscellaneous costs such as property advertising.
Cash flow tells you how much money you are gaining from the rental property, but don’t forget that you are also making money from equity growth and property appreciation.
How much cash flow is good for rental property depends on the investment and the real estate investor. An experienced investor with more money and a larger real estate portfolio would want higher cash flow and a higher return on investment than a beginner real estate investor.
Generally speaking, there are 3 types of investment properties when it comes to cash flow investing:
1- Negatively Geared Property
However, some accept the losses, hoping that they will make up for it through capital growth. In the meantime, an investor following this strategy will have to cover rental expenses from pocket or from the cash flow of another rental property.
In the long run, investing in a negatively geared rental property is not favorable as you might risk losing the investment property if capital growth doesn’t occur.
2- Neutrally Geared Property
A neutral cash flow situation is when you neither make nor lose money from the rental property, a break-even scenario. In that situation, you can opt to increase the rent or cut down on some costs. For example, if professional property management is costly, then you might consider doing it yourself.
3- Positively Geared Property
When it comes to how much cash flow is good for rental property, positive cash flow is definitely the optimal situation. The best cash flow rental properties are those with positive cash flow at the end of the billing cycle. This way the investment property pays for itself while you still enjoy extra cash income.
To find the best positive cash flow properties in your city and neighborhood of choice, click here.
How to Calculate Cash Flow
Let us now illustrate the cash flow calculation using a 5-unit multi family rental property ($800/month each) as an example.
- Purchase price: $400,000
- After a 20% down payment – $320,000 are financed
- A mortgage for 30 years at 5% – $1,720 monthly payment
- Taxes and insurance around $4,000 per year
- 6% vacancy and 1% miscellaneous costs
Cash flow calculation:
1- Gross rental income $800 x 12 months x 5 units = $48,000
2- Mortgage payments + insurance + taxes – $1,720 x 12 months + $4,000 = $24,640
3- Vacancy cost = 6% x $48,000 = $2,880
4- Other costs = 1% x $48,000 = $480
Cash flow = $48,000 – $24,640 – $2,880 – $480 = $20,000 or $1,667 per month of positive cash flow.
How Much Cash Flow Is Good for Rental Property? – The Truth
Since cash flow is merely a value, it is difficult to say how much cash flow is good for rental property. While it is correct to say that the more cash flow you get out of a rental property, the more money you will make, other real estate metrics quantify cash flow for a better understanding of an investment property’s performance.
Cash on cash return and cap rate are the most well-known indicators when it comes to measuring the performance of a rental property. Unlike cash flow, these metrics are expressed as percentages which can be used to compare different investment opportunities. Cash on cash return is a ratio that measures the annual cash flow before tax to the total amount of cash invested in the property. Since cash on cash return is represented as a percentage, it is a better representation of cash flow.
How Much Cash Flow Is Good for Rental Property? – What Matters
When it comes to real estate investing, some factors play an important role in deciding how much cash flow a property is going to make.
Location is the most important factor that governs the cash flow of a rental property. It is not fair to compare an investment property in a prime location to another location with low demand. Despite the higher rental income of a property in a prime location, other expenses are high as well.
Real Estate Investment Strategy
A short term rental strategy like Airbnb rentals tend to yield higher cash flow than traditional long term rentals. However, you should be aware of the higher risks involved in owning an Airbnb rental. Check the local laws for short term rentals before you consider investing in Airbnb property for cash flow.
Investment Property Type
Different property types have different cash flows. A multi family rental property can surely yield a higher cash flow than a single family rental. The risk of facing a 100% vacancy is much less when owning a multi family rental.
Mashvisor: The Fastest Way to Find Positive Cash Flow Properties
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