There’s a lot of money in real estate if you know what you’re doing. If you go in without a solid understanding of what’s involved, though? You’re wasting more than time and energy.
You’re potentially throwing away every last cent you’ve invested.
Knowledge of your local real estate market and an understanding of what constitutes a smart investment is a good place to start. It’s equally important, however, that you grasp the concept of cash flow. By knowing both how you’ve invested your money and where it’s going after everything is said and done, you’ll take a huge step towards financial success.
Let’s start by explaining the concept of positive cash flow, then we’ll move on to a few strategies for generating it.
What Do We Mean By Positive Real Estate Cash Flow?
Cash flow is basically what it sounds like.
It’s a measure of how money moves through a property. When you get more money out than you put in, you’ve got positive cash flow. When a property costs you more money than it makes you, that’s negative cash flow.
Note that cash flow can be measured in multiple ways. If, for instance, you’re purchasing a home with the intent of flipping it, you have positive cash flow if you make more money from the sale than you invested into the initial purchase and renovations. If you own and operate a rental property, meanwhile, your cash flow is positive if you’re making more from rent than you’re spending on maintenance and upkeep, even if it’s only a hundred dollars or so.
It’s also important to understand that negative cash flow isn’t necessarily a bad thing. As you gain expertise in real estate and knowledge of the difference between a good purchase and a bad one, it’s entirely possible to justify the purchase of a property with negative cash flow. So long as there’s the possibility that you can push things into the black, you’re not wasting your money.
How Is Real Estate Cash Flow Calculated?
Although the concept of positive cash flow is fairly easy to understand, the mechanics of it are actually quite complex. Determining whether or not a property you plan to purchase will generate positive cash flow requires a great deal of knowledge and research. You need to understand, in no particular order:
- Your city’s real estate market. Is your city likely to experience a real estate boom in the next five years? What about the next ten years?
- The neighborhood in which your property is located. What’s the crime rate? How many new businesses have moved into the area or left the area recently? Is the area undergoing gentrification, or is it suffering from stagnation or urban blight?
- The condition of the property. How likely is it that you’ll have to deal with a hefty repair bill within a few years of making your purchase?
- Your city’s rental market. Is your city core filled with countless vacant apartments and condominiums, or is there a constant flow of people looking to rent?
- Other expenses. Will you hire a property manager? Involve a realtor in your purchase? Spend money on marketing or advertising?
- Rental costs in your neighborhood. In real estate, the golden rule for rental properties is that your monthly rent should be equal to or greater than one percent of the total cost of your property. If you’re unable to justify that cost (ie. other properties in the area have prices that are significantly lower) then you may want to reconsider your purchase.
With the above in mind, The Balance Small Business Blog has put together a simple formula for calculating your cash flow in rental properties. First, you’ll want to determine how much you’ll be paying for your property on a monthly basis, then translate that into an annual total. Be sure to include not only your mortgage payments but also your taxes and insurance fees.
Next, study the properties in your area to give you an idea of the general vacancy rate you might expect. The Balance suggests at least six percent, though you may want to adjust this depending on your research. You should also study how much the previous owner spent on maintenance and repairs, and budget accordingly.
Finally, leave yourself a bit of wiggle room for miscellaneous expenses, such as property management or marketing/advertising.
Calculating the cash flow for buy-and-hold properties (assuming you aren’t renting them out) is a lot simpler. Simply subtract the total investments made into the property from what you sold it for. Be sure to include mortgage, insurance, property tax, renovations, and any other miscellaneous fees such as unexpected maintenance costs.
Investment Strategies To Master Your Property Cash Flow
Aside from arming yourself with knowledge of the rental and real estate market in your city, there are a few other things you should do to get the highest yield on your real estate investments. First, only rent to tenants you’re positive you can trust. You want to perform a thorough background check on an individual before you even think of allowing them to set foot in one of your properties.
Second, shop around when looking for a mortgage broker. You want to find one that gives you the best, most stable offer. The lower your interest rates, the easier it will be to generate positive cash flow.
Finally, you might consider purchasing older properties and renovating them, or else looking to add high-value renovations to your rental units. Bear in mind that not all renovations are created equal, and certain projects won’t add enough value to be justifiable. Per the Money Crashers finance blog, the highest-yield renovations for residential properties are as follows:
- Remodeling the kitchen
- Repainting the walls
- Installing energy-efficient appliances
- Adding a new bathroom
- Increasing the property’s square footage
- Adding energy-efficient windows
- Adding a deck
- Improving the insulation
For commercial properties, it’s a bit more complicated. Generally speaking, you’ll want to think about the type of tenant you wish to attract and remodel according to their unique needs. With that said, projects that improve energy efficiency will result in overall lower costs, so they’re never a bad idea.