As you’re shopping for your first investment property, you’ll realize that there are many options to choose from which can be a little bit overwhelming. What kind of property is best to buy for real estate investing? Well, the answer depends on several personal factors like your preference, how much you can afford, your optimal rental strategy (traditional vs Airbnb), etc. However, there are some features that must be found in the rental property itself in order to consider it a good investment. The most crucial feature is its ability to generate real estate positive cash flow. What is positive cash flow and why is it so important to property investors?
Related: Top 6 Characteristics of Profitable Investment Properties
What Is Positive Cash Flow in Real Estate?
Cash flow is the amount of money coming in and out of your rental property business. Hence, the positive cash flow definition is: when the total amount of money coming from an investment exceeds the amount of money needed to operate it (after tax deductions and depreciation are taken into account). From this definition alone, beginner investors start to get an idea of what makes positive cash flow properties highly attractive for making money in real estate. But for more details, here are 5 important reasons to look for real estate positive cash flow in any rental property for sale:
1) The Property Pays for Itself
Having access to a stream of rental income at the end of each month has an obvious appeal and is one of the most popular reasons people choose to invest in real estate. Of course, real estate investments come with expenses for investors to cover. These include mortgage interest, investment property management, repairs and maintenance, in addition to advertising and marketing costs. After buying rental property, usually one of three scenarios will happen:
- The investor would take this income to pay for the recurring costs of owning the investment. If all of the property’s income goes to cover these expenses, you’ll have zero cash flow (there’s no cash left for you).
- The investor would need to put more money from his/her own pocket to keep the rental property running. When the rental property costs more than what it makes, you’ll have negative cash flow (you’re actually losing instead of making money).
- The investor would cover all costs of the property from a portion of the rental income and keeps the remaining to him/herself (this is your monthly profit). As you can expect, this is when investors generate real estate positive cash flow.
As you can see from the three scenarios, the last one is where you can actually make money from investing in real estate. Not only that, but this also means that positive cash flow homes pay for themselves! Once you’ve paid your down payment to finance your property investment, you won’t need to spend any money from your pocket again. In other words, this type of income producing asset “pays you” to own it. Positive cash flow can help you easily pay off the money you initially invested, reduce your hours at work, and even retire.
2) Narrows Down Your Property Search
Based on the real estate positive cash flow definition, investors can also use this as an analysis metric to narrow down their investment property search. As a matter of fact, cash flow is one of the most important numbers in real estate that provide an insight into a rental property’s financial performance. You don’t want to invest your time and money on a property that doesn’t promise anything in return, do you? So, once you have found several rental properties for sale that interest you, one way to decide which one makes for the best real estate investment is by calculating the expected cash flow of each one.
Related: Learn How to Calculate Rental Property Cash Flow
Real estate positive cash flow is the core of a good rate of return on a rental property. This is because cash flow is used in calculating both the cap rate and the cash on cash return – the two most critical metrics to determine a property’s profitability. Thus, calculating positive cash flow is the first step in rental property analysis. Running this analysis is the best way to compare investment opportunities based on the numbers behind each real estate deal. In return, this ensures making smart investment decisions based on reliable property data – not on emotions that can lead you to invest in bad deals. Knowing that you’re about to buy a positive cash flow property for sale will make you feel less stressed and more confident as a real estate investor.
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3) Makes You More Attractive to Lenders
Another benefit of acquiring a real estate positive cash flow rental is that it adds to your borrowing power! If you’re planning to use a loan to purchase your investment property, you ought to know that lenders will look at a few things to determine whether or not you’ll get approved for a loan and how much to lend you. A conventional mortgage lender checks your income, credit, and assets. However, if you want to take a loan from an asset-based lender, these lenders are more concerned with how much income the property will generate. They use the debt service coverage ratio (DSCR) of the property to decide if it justifies a certain loan amount.
To calculate the DSCR, lenders divide the property’s net operating income (NOI) by its total debt service obligations. A DSCR above 1.0 means the rental generates enough cash flow to cover its debt obligations. A DSCR below 1.0 means that it doesn’t. When you approach a lender and show that the property you’re planning to buy for real estate investing has a debt service coverage ratio well above 1.0, this can make you more attractive to them. As a result, you’re more likely to get approved for the loan not only because you’ll have extra income, but also because lenders will see you as a talented investor who knows how to find positive cash flow investment properties.
To start looking for and analyzing the best cash flow investment properties in your city or neighborhood of choice, click here.
4) Lowers Your Real Estate Investing Risks
When starting a real estate business, it’s best for beginners to start with a safe investment. Some like to invest in residential property for appreciation or long-term capital growth. Nevertheless, investing for real estate positive cash flow is said to be the safest way to invest. When your money is tied up in the property, the only recourse when things go off the tail is to sell the property in a hurry to free up cash. This can be disastrous in a real estate market facing a downturn and, in some cases, could even cost property investors to lose their initial down payment. With positive cash flow investments, on the other hand, the property will pay for itself regardless of whether the market is rising or falling.
In addition, buying a rental property that is cash flow positive protects you from other risks. For example, you may have a period with no tenant, but you still need to pay the mortgage and utility bills. Moreover, you’ll have to pay repair and cleaning bills as you prepare the rental property for the next tenant. If you don’t have extra income, where are you going to get the money to cover these costs? Positive cash flow in real estate can reduce your risk as you can use it to help you out until the situation improves instead of having to sell and lose your investment property.
Related: 10 Major Risks of Real Estate Investing and How to Reduce Them
5) Builds Your Real Estate Investment Portfolio
If you’re looking to keep investing in the long-term, then buying positive cash flow property for sale is the first step to building your rental property portfolio. The extra money from real estate positive cash flow doesn’t only enable you to pay off the property. It also contributes to saving for another down payment to buy your next income property sooner. The more properties you buy, the more you can save, and the faster you can achieve your real estate investing goals.
The extra income from positive cash flow homes is not the only advantage that helps you grow as a real estate investor. The other is that you also have the possibility of making a capital gain as the value of your rental property goes up over time. Properties that are cash flow positive allow you to receive extra income AND gain exposure to upside capital growth. Meaning, you can be investing for positive cash flow and real estate appreciation at the same time! The best positive cash flow investments provide income that keeps you afloat and allows for capital growth over the long-term. Positive cash flow properties that appreciate quickly are known as the “holy grail” for real estate investors.
The Bottom Line
No investor should buy a property that shows no promise or potential for making money in real estate. This is the main reason why finding a real estate positive cash flow rental should be your top priority when conducting your property search and property analysis. Nonetheless, finding a positive cash flow property for sale is not as easy as you may think. You need to first identify a profitable real estate market, determine the best neighborhood, and find real estate comps to make sure you’re buying the right income property.
To make things easier, Mashvisor provides you with all the tools real estate investors need to find real estate positive cash flow investment properties in a matter of minutes! Start out your 14-day free trial with Mashvisor now to give them a try!