When it comes to owning or managing a rental property, one of the most important aspects of being a successful investor is ensuring that you have enough cash flow for covering contingencies and unexpected expenses and generating income. Understanding rental real estate cash flow and knowing how to calculate it opens up many opportunities for real estate investors to enjoy the several benefits of this lucrative investment vehicle.
The problem is that if you have not been in the real estate business very long, then you might not know how to calculate cash flow from your rental property. However, don’t worry as we have you covered.
What is Cash Flow?
Basically, the cash flow from a rental unit is the money you’ve left over after deducting all your expenses from the income. You have to subtract various expenses from your rental income to calculate cash flow from a rental property. These expenses include mortgage payments, insurance costs, and taxes, etc.
The cash flow projection of any real estate investment is known as the pro forma cash flow. This cash flow projection allows investors to easily evaluate the overall cash flow of a rental property for a certain period of time in the future.
How to Calculate Cash Flow?
A simple and quick cash flow calculation for a rental property can illustrate its potential as an investment. We will use a fourplex in our example. We are assuming that all the four units in the property are expected to go for full-time rental.
Start With the Basics
Here is the amount you can expect in cash flow from your rental unit. Suppose the purchase price of your property is $325,000, and you put 20 percent down—which comes to $65,000—and financed the remaining $260,000. The mortgage on your property is a thirty-year loan at an interest rate of 6.5 percent with an interest and principal payment of $1,643 each month. Also, suppose that insurance and taxes at the date of purchase are $3,600 per year, or $300 each month, for an aggregate payment of about $1,943 per month.
Cash Flow Computation
When calculating cash flow from a rental property, you will have to factor in vacancies. You are seeing a steady and stable rental demand for your rental units, and all of them stay occupied most of the time. However, to make prudent calculations, we will assume a 6% vacancy rate and non-payment risk in order to anticipate realistic cash flow.
The rental units are all identical. If they each fetch $900 a month in rent, the calculation will break down this way.
- Your gross rental income is 4 units x $900 x 12 months = $43,200 a year
- Your annual payments are $1,943 x 12 months = $23,316 a year
- Credit loss and vacancy is estimated at six percent of rents, or $2,592 a year
- The repair expenses incurred by the previous owner averaged $1,700 a year.
- You expect to spend around $400 a year in advertising and miscellaneous costs, and you will manage this rental property on your own.
Remember that real estate is, well, real. It is physical, and just like everything physical, it can fall apart if it is not maintained properly. And that is why you need to consider repair expenses of $1700 a year. Rental properties do not have perfect, 100 percent occupancy rates. After a tenant moves out, usually it takes some time to replace the carpet, repaint, clean the unit, advertise and stage it for rent, show the property to prospective renters, and sign a new lease agreement, etc.
It is worth mentioning that brand new homes need little maintenance and repairs, especially in their early years. On the other hand, older homes need more repairs and maintenance.
Note that these are the basic or core operational items that often go into most cash flow calculations. Rental income less payments less vacancy loss less expenses is equal to your cash flow:
Your gross rental income is $43,200. You will have to subtract $2,592 (vacancy factor) and $23,316 (taxes, mortgage, and insurance) and $2,100 (repairs and costs). This will be equal to $15,192. This will work out to $1,266 a month in positive cash flow over twelve months.
Other Calculations
This is not the one and only way to calculate cash flow for your rental property by any means, though it may well be one of the easiest. This is why you may include some additional calculations when evaluating an investment property on the way to your bottom line.
Final Thoughts
Calculating the cash flow from a rental property is important to evaluate whether or not making an investment in that property is financially feasible. Together with some other investment analysis metrics, like the cash on cash return from your property and cap rate, cash flow could be used in order to compare different types of real estate investment opportunities in the market. This is why learning how to calculate cash flow from a rental unit is essential when it comes to investing in a rental property.