How to calculate cash flow in real estate

When you ask a real estate investor how he or she gets into the business, the reply often boils down to these two: by engaging in the traditional method of buying and holding single-family rental or rehabbing or by purchasing commercial real estate like storage, apartments, strip mail and so on. These two methods are the most popular ways a potential real estate investor can get started with investing in real estate. 

When a real estate investor buys an investment, he or she would either decide to fix it up and manage it or rent it out. Depending on the choice of the investor, managing the rental property is usually the best way to achieve a good return on the property.

However, one major factor every aspiring real estate investor must take into considerations is how to calculate cash flow on real estate. Cash flow is the lifeline of every real estate investment. Your level of understanding of this basis can make or mar the investment. When the investor has a full grasp of the ways to calculate cash flow, he or she would be know how to choose properties that promise a positive cash return. Luckily, calculating cash flow in real estate is simple, succinct, and straight-forward.

What Is The Cash Flow?

The simplest definition for cash flow is the difference between the total money spent on the landed properties and the amount generated from the property. It is the difference between the property income and property expenses. 

Property expenses would include the amount used in acquiring the property, the debt incurred, the expenses, and the amount used in fixing the properties. All these would be calculated and compared to the amount generated from the property either on a monthly or yearly basis. 

As against stocks, bonds, and other related investment that uses the term "return" to refer to its profit, cash flow is a term used for landed properties such as real estates and rental properties.

There are two types of cash flow in real estate: 

• Negative cash flow
• Positive cash flow

Negative cash flow occurs when the amount spent on the properties, including the amount used in acquiring the properties and the expenses, is higher than the income generated from properties. In this kind of situation, the landlord or investor losses out every month.

However, a property has a positive cash flow if the income generated from the property is more than the expenses. Hence, the landlord profit from the property every month. 

In real estate investment, what investors look out for is rental properties with positive cash flow. The higher the cash flow potential of a real estate, the higher the potential for a positive return and fewer income expenses. Landed properties with high positive cash flow give the landlord something to fall back on in the case of an unexpected expense such as pipe burst, new AC, or roof replacement. 

As an investor, the more the positive cash flow, the more you will be able to maintain your investment and sustain your business expenses in all weather.

How To Calculate Cash Flow In Real Estate

Calculating cash flow is very simple, all you have to do is follow these simple process:

• Calculate the gross income from the property
• Deduct all expenses on the properties
• Remove all debt incurred on the property
• The difference in the result you have in your cash flow

Gross Income

In real estate, gross income is the total income from all sources before any expenses or mortgage payment is made. Usually, properties like single-family rental would only have one gross income which is the rental income. However, in the case of commercial properties, there would be additional income such as late fees, onsite income, pet fees, or fees on product sales like moving supplies. 

Expenses 

The expenses generated on real estate depend on the type of real estate. If for instance, the property acquired is a commercial property that has net leases, the expenses generated on the property would not be as much as residential rental properties. This is because commercial rental properties use net leases while residential properties make use of gross lease.

When you subtract the property expenses from the gross income, the result is the cash flow from operation or your net operating income (NOI). NOI is mostly used in commercial real estate and does not include debt incurred for other payments such as a mortgage. 

NOI is the cash flow generated from the property if there are no expenses.

If there are debts incurred on property, this can be subtracted after the expenses so as to provide the property cash flow after financing  

Property debt

This refers to the debt incurred when fixing the property. Such debt might be used to cover expenses such as mortgage debt.

The 1% Rule

If the property expense is not available upfront, it is advisable to use the 1% Rule. The rule helps you to analyze the property and to determine if it is a worthwhile investment. The 1% Rule is used in real estate investment to determine if a real estate investment would have a good positive cash flow. It also helps to determine the positive cash flow potential of the property. 

The 1% Rule simply states that the property rental rate should be at least one percent of the purchase price. For instance, if the property is for sale at $30,000, the least rental income the property should be worth is $3,000 per month. The property is expected to worth more than this per month. However, if the property month rental income is at $2,000, it doesn’t satisfy the rule. As such, there is a tendency for such property to have a negative cash flow. If on the other hand, the property rental income per month is worth $4,000, it has a good possibility of substantial positive cash flow.

In real estate, the higher the rental income as against the purchase price, the higher the potential for good positive cash flow. Good cash flow is determined by comparing the rental income with the purchase price.

It is important to note that the 1% Rule does not apply to all kinds of real estate properties. For instance, if the rental property is located in a city where real estate is very expensive and with high property tax, or if the property is located in an area prone to hurricane or flood and would require additional insurance payment to cover all these, using the 1% Rule might not be able to determine whether or not the property would yield a positive cash flow. 

Summary

According to a popular saying in real estate, "cash flow is king." The higher the cash flow on the properties, the greater the chance of keeping the properties afloat. 

Therefore, for every real estate investor, investing in properties with positive cash flow should be your focus.  Although finding a property with positive cash flow is not an easy feat, when you understand how to calculate your cash flow, it would be easier to determine properties with good cash