One of the metrics you need to consider as an owner of a single-family rental property is its cash flow. The cash flow refers to the amount of money that is left after you’ve deducted your rental-related expenses, such as your taxes, utilities, and repairs. By calculating the cash flow, you’ll be able to determine whether or not a particular property is worth investing in – in other words, if it has the potential to be profitable. With that in mind, the cash flow calculation should be done before purchasing a property, preferably by a real estate professional such as a property management agent.
What is cash flow?
If you’re wondering what cash flow is, we’re here to break it down for you. Think of cash flow as the amount of money that your rental property earns, often in the form of rental income. However, as cash flows into your rental, some of it gets taken away due to the day-to-day expenses of property management.
As a general rule, the cash flow should be positive. That’s because you need to be able to pay for your expenses and prepare for unexpected repairs. If your rental property isn’t making money, you’ll likely have to pay out of pocket and you never want that.
Why should you always calculate the cash flow?
Planning on purchasing a single-family rental home? Don’t forget to calculate the cash flow! If you fail to calculate the cash flow, there’s a chance that you’ll end up with a property that costs more to operate. Even if your real estate investment is occupied, if your expenses exceed your rental income, you will probably end up in debt. In the end, you’ll have to sell your real estate investment.
If you don’t want to be stuck with a property that doesn’t make money, be sure to ask a property management firm to help you run the numbers.
What expenses should you consider in a cash flow calculation?
Below, we’ll explain the expenses you need to consider when you calculate the cash flow.
You can’t expect your rental property to be occupied 365 days a year. Even if your single-family home is in a popular area, there will be times when it’ll be vacant. Over that period, you will have to continue to do repairs, maintenance, and more. Your expenses will pile up, and if your cash flow for the rest of the year (i.e. when the property is occupied) can’t offset these, you will be in serious trouble. Also, make sure that the market you’re investing in has a low vacancy rate. That way, you can anticipate a consistent cash flow and not have to worry about whether or not you’ll eventually have to deal with a long-drawn-out vacancy.
Maintenance and Repairs
Maintenance pertains to the routine tasks you do to make sure the property is in tip-top shape. In other words, they are expenses that you expect from the start. Repairs, on the other hand, are unpredictable but still need to be done, otherwise, your property will be deemed uninhabitable. Both are important, which is why you also need to prepare for them.
Ask property owners to know how much you’ll likely spend on maintenance, repairs, and more. Take those into account and check if you’ll still have a positive cash flow even with the costs. It would also be wise to set aside funds for big repairs as you never know when you’ll be hit with a $5,000 bill for a roof replacement.
Property Management Fees
If you’ve partnered with a South Florida property management firm (if you haven’t, you seriously should), you’ll need to take into account the fees that you pay them. Some property management firms charge a one-time fee, while others charge a percentage of the rent, plus additional fees for finding tenants, screening tenants, and so on. Be sure to consult your property management agent about their fee structure so your cash flow calculation will be as accurate as possible.
Thinking of taking out a mortgage to pay for your rental property? Make sure to get an estimate of how much you’ll likely pay your insurer, as well as the interest rate that they’ll put on top of it. Your mortgage will take a huge chunk out of your cash flow, so don’t forget to account for it in your cash flow calculation!
You’ll have to account for every little expense that you will incur over a year. Keep in mind that only you or your property management agent knows what expenses to expect since they are dependent on your property’s distinct needs. In other words, one investor’s expenses are never exactly the same as yours. An example is the marketing expenses – you can choose to go all-out, or you can count on free marketing strategies like social media.
What’s the formula for calculating the cash flow on a rental property?
Here’s a simple way to calculate your single-family home’s cash flow:
- Get the gross income. This refers to the rental income and additional income streams such as pet fees and late rent fees.
- Deduct all rental-related costs from the gross income. This will result in the net operating income (NOI).
- Subtract the debt service (e.g. mortgage payments, taxes, insurance, etc.) from the NOI to get the cash flow.
Let’s take a look at an example:
If your annual rental income is around $50,000 and the expected expenses amount to $6,000 a year, your NOI is $44,000. However, your expenses for the mortgage interest, insurance, and taxes are at $20,000, so your cash flow is $24,000 or $2,000 over twelve months.
What’s the 1 percent rule?
Don’t know what expenses you’ll likely incur? You can use the “one percent rule” to determine if a particular property will have a positive cash flow. Basically, if a property is priced at $200,000, its rental income should be at least one percent or $2,000 per month to be profitable.
Need help calculating the cash flow?
Aside from Luxury Property Care’s expert property management services, we also provide investment services to South Florida property owners. With us by your side, you can benefit from having a team of professionals tell you what to do and what not to do when it comes to real estate investing. We’ll determine whether or not a particular property is worthwhile, or if it’s only a waste of time!