- December 15, 2020
- Posted by: Editor
- Category: Advice
Every real estate investor is looking to make a good return on investment (ROI) from their rental properties. A good ROI typically boils down to good cash flow. We need to understand what cash flow is, how it works, and how much rental property cash flow is considered good.
In simple terms, real estate cash flow is the difference between money going out from your rental (expenses) and money coming in (income). A positive cash flow is when income exceeds expenses, while a negative rental property cash flow is when expenses exceed income.
Here are some of the benefits of having a positive rental property cash flow:
- Creates freedom – When you generate steady profits from positive cash flow income properties, you will have time to focus on other projects that you are passionate about. You will also be able to spend more time with friends and family.
- Creates safety – The monthly income generated from cash flow properties will boost your savings, thus safeguarding you from unexpected life expenses such as car maintenance and medical bills.
- Creates opportunity – You can reinvest the profits from positive cash flow properties into other investment properties, thus growing your portfolio and earnings.
How to Calculate Rental Property Cash Flow
Calculating rental property cash flow is very easy. Here is the formula:
Cash flow = Gross rental income (GRI) – Total expenses
Gross rental income is the total income generated from all sources before any expenses are incurred. Besides rent payments, GRI could also include income earned from renting appliances to tenants, parking space rental, pet fees, vending machines, late fees, or laundry machine access.
Operating expenses include all costs involved in running your rental property. This includes property management fees, legal fees, maintenance costs, property insurance, marketing costs, property taxes, business licenses, and utility expenses.
Another crucial thing you need to consider when computing rental property expenses is vacancies. Since a vacancy represents a loss in income, it should be included in your rental property cash flow calculation. Let’s say you own five units, and the rent for each unit is N500000 per annum. If one unit is vacant, you should add N500,000 to your operating expenses.
How Much Cash Flow Is Good for Rental Property?
Generally, any amount of positive rental property cash flow can be considered good. However, what makes cash flow ‘good’ varies from one investor to another. While some real estate investors are only interested in a minimum return on investment (ROI), others want to generate enough cash flow to meet specific cash on cash returns.
Here are some formulas you can use to determine if cash flow is good:
- The 1% rule – To establish if a rental can generate positive cash flow, use the 1% rule. This rule states that for an investment property to be considered a cash flow property, it should rent for no less than 1% of the purchase price. For instance, if you buy an investment property for N20,000,000, the rent should be at least N200,000 per month. However, just because a property satisfies the 1% rule, that doesn’t mean that you should rush to buy it. You must also consider other factors and expenses like vacancy rates, property taxes, insurance, and property management fees.
- Cash on cash return – This is calculated by dividing the net operating income by the amount of money invested in the property. For instance, if you make a down payment of N3000000 on a rental that generates an income of N400,000 annually (after paying bills), the CoC return would be N400,000/N3,000,000 x 100 = 13.3% In terms of cash-on-cash return, a good cash flow property is one that generates a return of 10% or more.
- Cash zone – Divide the gross annual rental income by the property price to get the cash zone. For example, if the gross annual rental income is N200000 and the property price is N2,000,000, the cash zone will be N200,000/N2,000,000 x 100 = 10%. As a rule of thumb, the cash zone should be 8% or more for a good rental property cash flow.
Ways to Boost Cash Flow
No matter your level of earnings, the good news is that there are ways to boost your cash flow. Here are some strategies to consider:
- Minimize vacancy rates – Tenant turnover is one of the greatest cash flow killers. Think of how to keep your tenants happy in order to boost your traditional or Airbnb occupancy rate. First, be sure to respond to tenant requests and complaints in a quick and professional manner. Offer them privileges like free WiFi or subsidized access to the gym. Don’t be quick to increase rents when leases expire.
- Appeal property taxes – property taxes are usually increased every year, thus eating into your cash flow. If you feel the increase is not fair, consider appealing to the local government.
- Preventative maintenance – Major repairs that are unexpected can have a negative effect on your cash flow. To avoid this, you need to conduct seasonal maintenance on major areas like plumbing systems and HVAC units.
- Renovate the rental property – You could improve the property by using updated finishes and installing energy-efficient appliances. Tenants will feel like they are getting value for their money.
- Increase rent – When you have made some renovations on a property, tenants would be willing to pay more since they are getting value for their money. They are also likely to stay longer.
While there is no amount we can label as “good cash flow,” it’s not difficult to figure out how much rental property cash flow is good for you and your business. As long as it’s positive and there is enough of profit to achieve your real estate goals (whether it’s saving up for another rental property or just having some extra cash every month to spend), then you’re generating a good cash flow.
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