Real estate investors who earn a living from rental income all know one thing. Positive cash flow is the single best way to evaluate the profitability of a rental unit. Expand that premise to one’s full business and it is easy to see that the cash flow of income-producing assets is the cornerstone of the business. Here is Mashvisor’s guide to avoiding negative cash flow rental property when buying, and to making certain when owning a rental property, your cash flow stays positive.
Tip 1 – Avoid Negative Cash Flow by Using a Calculator
The single best time to avoid negative cash flow is before you purchase an investment property. During the search phase, you know your down payment limits and you can evaluate various properties available to find the best one. Adding in more capital, and thus reducing the monthly loan, is the easiest way to reduce negative cash flow, or reverse it. However, that capital has value and using too much of it comes with an opportunity cost. That cost being the lost opportunity to invest in another property, or use that capital in other ways. To ensure that you evaluate the investment properties fairly, use the same capital investment for each you consider and see how the cash flow works out. Mashvisor has a calculator that can help you:
Mashvisor’s Rental Property Calculator
Real estate investing for beginners can be a bit complicated. One mistake that many new to investing in rental property make is trying to invent a perfect spreadsheet (Your author is guilty of that mistake). The idea is that you will build a model to crunch numbers comparing all aspects of real estate choices. There is nothing wrong with trying the exercise, but experts have already done that work for you. One example is Mashvisor’s rental property calculator. It will provide you with three metrics that you need to know. These include cash flow, cap rate, and cash on cash return.
Related Story: The Best Investment Property Calculator For 2019
Because your goal here is to avoid negative cash flow, it’s important to know that Mashvisor’s calculator acts as a cash flow calculator. A cash flow calculator is a simple tool that helps you to look at just the monthly rental income and the monthly expenses of a real estate investment property. Mashvisor gathers local data from the investment market in order to conveniently display this information for you. You can then adjust expenses as you see fit.
Using this data, you can perform a complete cash flow analysis. Cash flow is the net operating income of your rental property. Think of it as the amount of income left after all the expenses and bills have been paid. An accurate cash flow analysis is sure to help you avoid negative cash flow properties.
If you are going to use just one tool, this is the one to start with. Why not give it a try for free right now and get 20% off when your trial ends?
Tip 2 – Occupancy Rate and Tenant Turnover Are as Important as Rent $s
Calculators like the one we have overviewed above are really great tools for avoiding negative cash flow. However, we feel it is important to emphasize one particular aspect of cash flow. That is the occupancy rate and tenant turnover. When using a cash flow calculator, it is easy to assume that your monthly rent will actually be monthly. Or that your Airbnb will be nicely booked every period you offer it. Of course, that is not the case and occupancy rate matters a lot.
Here’s why. Imagine you rent out an apartment for 12 months at a rate of $1,200 per month. Let’s assume that you use an agent to help you fill your unit. The typical management fee is one month’s rent to fill a rental. That means that 1/12th of your rent is gone before you even get a check to cash. If your tenant stays for 10 years and you raise the rent each year to cover your costs and maintain profitability, super. You are winning. That rental fee is now meaningless. It is now just 1/120th of your income. Tenant turnover can be expensive and can destroy your cash flow model, turning it from positive to negative.
However, you can’t screen tenants based on their likelihood to stay long term (legally). While that is true, you can account for it in your rental property cash flow calculations. If you rent to seniors, you will have a high retention rate and low turnover. If you rent to students, you will have a very high turnover and very low retention rate. Is your Airbnb in a location that has a seasonality effect? Say, a lake house, or is it near a sports stadium? Your occupancy rate is going to be seasonal as well. Our point is to be careful when you calculate your income from rent. Be sure to avoid negative cash flow by doing a true accounting of your occupancy rate and turnover because your costs and income will be directly impacted.
Tip 3 – Don’t Buy Money Pits
Before you purchase your next rental property, use a professional inspector to avoid money pits. A good home inspector can help you avoid a negative cash flow situation by predicting what your repair and maintenance costs will be. A home inspector will evaluate all of the money-sucking aspects of an investment property and give you an accounting of what to look deeper into. And this is advice you need to follow.
You can certainly negotiate with the seller if the real estate property has deferred maintenance or serious repair issues. In fact, you can locate bargains this way. However, it can also kill your cash flow and turn it negative. Here’s why. Let’s say you identify that the property will need $5,000 in heating work. It is easy to see that the seller may take $5K off of the price of the property. If they do, remember that your capital investment now needs to also change by a reduction of $5,000. Otherwise, that payment will come from your cash flow. If you are planning to buy an owner-occupied multi-family with a low-money-down mortgage, this can kill your cash flow. Just be smart and be sure that you account for the major repairs by setting aside capital. Don’t kick the can down the road and plan to pay from your earnings. The unit may be unoccupied for a while, and your cash flow can take a big hit.
There are also a few things that cannot be successfully repaired at a reasonable cost. These include septic systems, water wells, chimneys, and foundation and structural issues. Many states require that a septic system be professionally inspected by the seller and that it be up to code prior to the sale. That is helpful, but at some future point, that system will fail. When it does, your cash flow is going to turn negative fast. We suggest avoiding rental properties with septic systems, water wells, fireplaces, and any structural issues. This warning is particularly true for beginners who are new to investing and with only a few properties. The downsides are not in your control, and the costs can turn a profitable investment property unprofitable overnight. If you find a gem that you just can’t ignore, but which has these things, look into a home warranty policy. Be sure you know what you are getting into.
Investing in a rental property can be lucrative. One way to be sure you are keeping the business healthy is by avoiding negative cash flow before and during your ownership.