Acquiring rental properties, known as cash flow in real estate, can be a great way to generate a significant income passively. You purchase a property, rent it out to tenants, and collect rent payments from them each month.
Buying a rental property seems simple, but it takes more than that to guarantee it’s a wise investment. As a property owner, you should know how to calculate cash flow to maximize profits. No worries, you can incorporate real estate into your portfolio with the help of a financial advisor.
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What is Cash Flow in Real Estate?
Simply put, a cash flow refers to the movement of money going in and out of businesses. Accordingly, the cash flow definition in real estate refers to the money generated by a property like rental income and the costs associated with it.
There are two kinds of cash flows in real estate investments, positive and negative. Having a positive cash flow means the property’s income exceeds its expenses. On the other hand, negative cash flow occurs when expenses exceed income.
A positive cash flow is preferred because it indicates that the real estate investor is making money on the property they are investing in. Generally, the higher the profit margin, the better the return on investment. Additionally, positive cash flow can make upkeep, maintenance, and repairs easier on your real estate investments.
However, when a rental property loses money, it is considered negative cash flow. Property owners can experience negative cash flow if their properties sit vacant for a prolonged period or if rental rates don’t correspond to maintenance costs.
How to Calculate Cash Flow in Real Estate
Knowing a few key details about the property is the first step in calculating cash flow in real estate. To calculate rental property cash flow, you need the following information:
- Approximate gross income of the property
- Expenses associated with the property
- How much debt does the property have, if any
All rental income is expressed as gross rental income before any expenses, such as mortgage payments, are deducted. For residential rental properties, rent is typically your main source of income. Fees for pet ownership, late fees, or any other fee included in your lease agreement can also generate income for you.
Furthermore, all costs associated with owning the property will be included in the expenses side. Among these are:
- Property taxes
- Property management fees if the property is managed by another party
- Maintenance and repairs
- Business licenses are necessary for renting out the property
- Legal and professional fees like eviction expenses
The vacancy rate of the property should also be included when calculating cash flow. Property vacancies represent how many days a year there are no tenants on the property, meaning no income is generated.
Calculating Cash Flow
You calculate the vacancy rate of a property by adding up the time it’s been vacant over the course of a year, dividing the figure by how much time it could have been leased, and multiplying it by 100.
In other words, if the property sat vacant for 16 weeks but could have been rented for 52 weeks, it has a 30.76% vacancy rate. In the rental industry, vacancy rates are considered operating expenses.
The next step is to calculate net operating income (NOI), which is calculated once you have your gross income and expenses. For cash flow real estate, NOI is determined by subtracting expenses from income.
The result is the amount of cash flow generated by operations. Once you subtract debt service from net operating income, you will get net cash flow.
Factors that Hurt Your Cash Flow
To avoid having a negative cash flow, below are some of the factors you need to be aware of that could be detrimental to your cash flow.
Repairs and Maintenance
No one likes the idea of having to replace their furnace at their rental property. It’s never fun to have to fix a roof leak. However, they are possible and are bound to happen.
For these unexpected costs, it is ideal to save some of your income every month. Occasionally, your reserves aren’t sufficient to cover certain expenses, so you have to tap into your own pocket. Cash flow would be put at risk if that were to happen.
Inconsistent Stream of Income
You might have to deal with a tenant who doesn’t pay rent on time or who does not pay at all. In the event that your tenant fails to pay in full or misses a payment, your cash flow is severely reduced.
Moreover, you will be required to cover all expenses out of pocket—like mortgage if there is one, insurance, taxes, etc. Keep in mind that vacant properties do not generate income. Hence, a rental property cannot generate cash flow if it doesn’t generate any income.
Property Taxes and Insurance
Due to an increase in property taxes and insurance costs, your cash flow can suffer. The fact that these expenses can rise every year can catch you off guard at first, but you can be ready for it once you are aware. To avoid this, you simply have to look for a better deal and be prepared.
Why is Cash Flow in Real Estate Important?
When weighing new investment opportunities in real estate, cash flow is crucial. Investing in a rental property only to see it become a money pit is the last thing you want to do. Calculating cash flow in real estate could assist you in putting together an investment plan and avoid making a mistake.
In order to determine the profitability of rental properties, calculating cash flow is crucial. You can’t get an accurate picture of the market by simply looking at the rent you might be able to charge for a property.
In order to determine how much cash flow you’ll be left with, you have to subtract the property’s operating expenses and any debt payments you must make.
Make realistic projections for both rental income and operating expenses when making any real estate investment, as due diligence can make or break your business.
For a successful investment, work with an established company that you can trust. Invest in commercial real estate funds with Saint Investment Group, you may contact us at
President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.