One of the most important things for real estate investors is learning to come up with a very accurate rental property cash flow analysis.
Table of Contents
- Defining Cash Flow
- How to Calculate Cash Flow on Rental Property
- How to Determine If a Rental Property Will Cash Flow Positively
- How Much Cash Flow Is Good for Rental Property?
- What Rental Expenses Could Reduce Your Cash Flow?
- Four Tips to Increase Your Rental Property Cash Flow
Learning how to calculate rental property cash flow is one of the basics of real estate investing. At the end of the day, your goal in investing in real estate is to find the most profitable investments with positive cash flow.
Investing in rentals without knowing how to calculate cash flow is a trap that many investors fall into. But why is it so important to know what rental property cash flow is and how to calculate it? Simply because cash flow is the money you get to keep in your pocket after deducting all expenses. In other words, it is how you build your wealth in real estate.
We hope that by the end of this article, you understand how important rental property cash flow analysis is and how you can properly do it with the help of Mashvisor. The sooner you know about rental analysis, the better off you will be as an investor.
Related: Why Positive Cash Flow Is a Must With Income Properties
Defining Cash Flow
Before you learn to work on a rental property cash flow analysis properly, we first need to discuss the basics: What exactly is a cash flow? And how does knowing about it help your journey as a real estate investor?
What Is Cash Flow?
Cash flow is the difference between your gross rental income and rental property expenses. The cash flow projection of a real estate investment is called pro forma cash flow. This pro forma real estate projection allows investors like yourself to evaluate the overall cash flow of a property for a defined period in the future.
In this blog, we will show you how to calculate rental property cash flow for a single year. You can then determine the pro forma cash flow using the rental property cash flow value that you will obtain.
What Makes Cash Flow So Important?
Generally, an investor buys a rental property for several reasons. One is to diversify their investment portfolio. Two, rental property investment is a good hedge against inflation. The third and probably the most obvious reason is to improve cash flow.
Rental property investment is a very promising option for improving an investor’s cash flow. It is one of the most profitable investment vehicles any real estate investor can take. It is why most investors prefer to buy rental properties. Whether they start a traditional rental or an Airbnb business, the return on investment mostly will not disappoint.
Knowing how to calculate the cash flow on your potential rental property investment will help you determine whether it is a good buy or not. A positive cash flow means your gross rental income is greater than your monthly rental expenses. It simply means that the property takes care of itself while generating profit for you.
A negative cash flow, on the other hand, means that you’re losing money on the rental property. Your gross rental income is not enough to cover your recurring expenses, and you end up spending more money to take care of them.
Having this type of knowledge gives you an edge as an investor. It may not be as in-depth and thorough as a proper rental property cash flow analysis, but it will at least give you an idea of a rental property’s earning potential.
Understanding Cash Flow Better
To better understand how the final cash flow is calculated, we can divide it into three groups: cash flow from operations, cash flow after financing, and cash flow after taxes.
The final calculation leads to three results:
- A negative cash flow or negatively geared rental property: Investing in such properties is not favorable, but there are methods where you can turn a negative cash flow property into a positive one.
- A neutrally geared property: This situation means that the investment property is neither making nor losing money.
- A positive cash flow property: The optimal situation, meaning that you can still keep some money after operating costs, financial costs, and taxes.
Let us see how to calculate a rental property cash flow step by step.
How to Calculate Cash Flow on Rental Property
A significant part of your journey and growth as a real estate investor is knowing how to conduct a rental property cash flow analysis. We already put enough emphasis on the importance of a cash flow analysis for rental properties in the previous section.
In this section, we will teach you how to determine the cash flow for a rental property in easily digestible steps. But before doing so, here are a couple of different types of cash flow analysis:
Calculating Cash Flow From Operations
The first step of calculating your final cash flow is to determine the net operating income. NOI includes day-to-day operating expenses such as vacancy costs, management costs, property taxes, property insurance, property maintenance, and other costs, which can include a business or short-term rental permit, for example.
To calculate the net operating income, you simply subtract all the said costs from the gross rental income, which is the amount of money your tenants pay.
For example, a real estate property that is rented out for $1,700 has a gross rental income of $1,700. If we assume that the monthly operating expenses are as follows:
- 5% vacancy cost: $85
- 10% management cost: $170
- Property taxes: $2,000/year or $167/month
- Property insurance: $85
- Property maintenance: $60
- Short-term rental permit: $10
Net Operating Income = Gross Rental Income – Operating Expenses
= $1,700 – $85 – $170 – $167 –$85 –$60 – $10 = $1,123
The final step before calculating cash flow from operations is to deduct capital expenditures (CapEx). CapEx includes large expenses that do not recur regularly, like changing the roof or cooling system. Setting aside 5% of your gross rental income for CapEx is a good way to avoid rental property cash flow disasters.
Cash Flow from Operations = NOI – CapEx
= $1,123 – $85 = $1,038
Calculating Cash Flow After Financing
Most real estate investors use borrowed money to invest in rental properties. That is why it is important to calculate your cash flow after financing to ensure you still have money to pay your mortgage lender.
Let’s assume that the asking price for the property is $150,000. After paying 20% as a down payment, you finance the rest at 3% for 30 years. You can use an online mortgage calculator to calculate how much you need to pay every month. In this case, the monthly mortgage payment is $600.
Cash Flow After Financing = Cash Flow From Operations – Financing Costs
= $1,038 – $600 = $438
This is the amount of money that you can keep in your bank account. But is it all yours? Well, not really; you still have to pay your income tax bill. Depending on where your property is located, you will need to deduct a predetermined amount (cash flow after taxes).
Related: What’s the Best Cash Flow Calculator for Rental Property?
5 Steps to Calculate Rental Property Cash Flow
As an investor, you will need to know how to come up with a proper cash flow analysis on a rental property. Here are the steps to doing a proper cash flow analysis:
Step 1: Project Effective Gross Income (EGI)
The very first thing to do for your rental property is to calculate how much you can make for an entire year. We’re talking about the maximum gross amount. To get the figure, you need to take the following into consideration:
- Gross Potential Rent. This can be done in several ways, but for greater accuracy, we suggest using an investment property calculator from a real estate website like Mashvisor. All you need to do is add up all the potential rent the property can generate in a year.
- Additional Income Sources. On top of the rent, include other fees like parking, administrative fees, pet fees, and other similar items.
- Vacancy Rate. Factoring in the vacancy rate, or “downtime,” is a wise thing to do. As an investor, you don’t want any downtime between purchasing a property and getting a tenant. However, it is a reality a lot of rental property owners face. Make sure you find out the vacancy rate based on property and market conditions.
As an example, let’s say you charge a monthly rent of $1,500 and receive an additional income of $50. Based on your research on property and market conditions, you also found out that the monthly vacancy credit is presently at $30.
All you need to do is add your gross annual income on rent and other additional income and subtract your annual vacancy credit. It will give you your EGI.
EGI = $18,000 + $600 – $360 = $18,240
Step 2: Identify Gross Expenses
Owning a rental property entails a lot of recurring expenses. You need to identify all of the recurring costs so you can make an accurate cash flow analysis for your rental property.
Below are some of the most common recurring expenses for rentals:
- Maintenance and Repairs. As a rule of thumb, you should set aside around 2% to 5% of your monthly rent for regular maintenance costs.
- Property Taxes. Taxes vary per location so make sure to consult your real estate agent or a reputable tax professional in your area.
- Insurance. Insurance is a must for rental property owners. If you don’t have one, talk to different providers about your options and decide which product works best for you.
- HOA and POA Fees. Depending on the property’s type and location, you may need to make regular payments for HOA or POA dues.
- Management Fees. If you’re working with a property management company, this will also add to your monthly expenses.
- Other Expenses. Not all properties are the same. They generate different needs depending on various factors. Utilities, cleaning, pool or hot tub maintenance, and other similar costs need to be taken into consideration.
Step 3: Calculate Net Operating Income (NOI)
Once you obtain all of the above information on hand, you can now calculate your property’s net operating income. The formula for NOI is pretty straightforward:
NOI = Gross Income – Gross Expenses
When computing for your NOI, don’t forget to factor in certain capital expenses like major appliance replacements, roof repairs, and other similar large expenses. It is wise for you to build a reserve fund for big-ticket repairs and expenditures.
Step 4: Calculate Cash Flow After Debt
The final step to calculating your rental property cash flow is subtracting your annual debt from your NOI. It specifically applies to property owners who are using new financing. It gives them an idea of how much money they should put down and see how much they should spend to meet their goals.
Step 5: Analyze the Numbers
When you already know what your income and expenses are, you can now make a proper profitability and viability analysis. Run the numbers carefully and thoroughly, so there are fewer chances of errors. For this, we recommend using Mashvisor’s rental property cash flow calculator.
Mashvisor is powered by sophisticated AI that is highly interactive and intuitive and that adjusts to any input you make. And even if you don’t have all the actual numbers for the market your property is in, it will use up-to-date rental market data for the missing details. It makes data analysis a lot more convenient and efficient for a real estate investor like you.
This beats going the old-school route of using a spreadsheet and is definitely a lot better than just using Excel.
Using Mashvisor for Rental Property Cash Flow Analysis
Cash flow is the amount of money that you can keep in your bank account. But is it all yours? Well, not really; you still need to pay your income tax. Depending on where your property is located, you will need to deduct a predetermined amount (cash flow after taxes).
A rental property cash flow analysis can be done using a physical spreadsheet, software like Excel on your computer, or a real estate website like Mashvisor. All three ways are effective and will give you results. However, if you want truly accurate results, we recommend going with Mashvisor instead of a spreadsheet or Excel.
Mashvisor is a data analytics website that will give you real-time real estate market information. It maintains a vast database that covers almost every area of the 2022 US housing market and that is regularly updated specifically for data analysis. Lots of real estate investors use the website to make accurate cash flow projections and find the right properties according to their needs.
As a website, Mashvisor gives users access to the most relevant information, up-to-date data, and useful tools for a proper rental property cash flow analysis.
Learn how to find lucrative investment properties using Mashvisor. Schedule a demo now.
How to Determine if a Rental Property Will Cash Flow Positively
Normally speaking, there are signs of a positive rental property cash flow. An investment property located in a good neighborhood will usually yield a positive cash flow.
Such signs can be seen clearly when using a real estate investing tool like the heatmap analysis tool from Mashvisor. Based on investment properties in a given area, the heatmap tool can tell you which neighborhoods offer better cash flow.
Furthermore, a cash flow analysis, like the example above, is a must for each and every rental property investment. By failing to conduct one, you risk losing your property, especially when you don’t project the cash flow accurately.
Many investors find cash flow spreadsheets complicated and sometimes confusing. Fortunately, Mashvisor is here to help solve the problem. Mashvisor’s rental property cash flow calculator saves you the trouble of manually calculating your cash flow. Based on similar properties in the same location, the tool will provide you with an accurate calculation.
The 2% Rule in Rental Property Investing
In real estate investing, we have what we call the 2% Rule. This rule simply states that for a rental property to be worth your while, you should make no less than 2% of the property’s purchase price.
For instance, you bought your property for $300,000 and decided to make a rental out of it. According to the 2% Rule, you should be making no less than $6,000 in rental income in a month.
A lot of investors use the 2% Rule instead of the 1% Rule to ensure their rental properties generate a positive cash flow.
Related: Real Estate Investing 101: How to Find Positive Cash Flow Properties in the US Housing Market
How Much Cash Flow Is Good for Rental Property?
It is 100% correct to say that the more cash flow you get on your property, the more profitable the investment is. However, since rental property cash flow is a value, it is difficult to say what is a good cash flow rental property.
A good rental property cash flow is, therefore, any positive cash flow you can make out of your rental property. The more, the better.
Together with other investment analysis metrics such as the cash on cash return and cap rate, cash flow can be used to compare different investment opportunities. Understanding the meaning of the said metrics and learning how to calculate them is a must when it comes to investing in rental properties.
What Rental Expenses Could Reduce Your Cash Flow?
Investors get into real estate investing to make as much money as they possibly can while taking into account all related expenses. As a rental property investor, you should never cut corners on your rentals.
It will give you greater chances of achieving higher occupancy rates. However, you should also know how to keep your expenses to a minimum without compromising the quality of your rental property.
Previously, we discussed the different expenses associated with operating a rental property.
Maintenance and repair expenses can be kept to a minimum by regularly inspecting your property for any signs of wear and tear. The sooner you can spot a potential problem and prevent it from getting worse, the more savings you get on maintenance and repairs.
Taxes and insurance are two things you should never discount from your calculations.
As a real estate investor, it is your duty to pay property taxes. As we already mentioned, property taxes vary per state. So, it is best to consult with a tax expert to see how you can keep your taxes to a minimum legally. Regarding insurance, all you need to do is shop around for the best policy that will give you optimum coverage at the rate most affordable to you.
If you hold out-of-town investments, working with a project manager is considered an investment and not an expense. However, if you own several rental properties in your area, you can cut down on property management fees by doing all the work yourself. However, keep in mind that while it can be a money-saver, it can also be quite time-consuming.
4 Tips to Increase Your Rental Property Cash Flow
Earlier, we gave tips on how to reduce your expenses. Now, here are a few more to increase your rental property cash flow.
1. Keep Your Expenses to a Minimum
We already discussed this in the previous section. If you can look for other ways to minimize your monthly and annual expenses, even better. Just make sure you don’t compromise the quality of your property and the experience it gives your tenants and guests.
2. Add New Amenities
While this may seem counterintuitive to the previous point, adding new amenities that bring in long-term returns is a good way of increasing your cash flow. For instance, adding a washer or dryer may cost you some extra money initially, but tenants are willing to pay slightly higher rent.
3. Provide Additional Services
Another effective way to boost your cash flow is to provide additional services to tenants and guests in your area.
For example, if you have ample parking space, you can charge parking fees to your tenants or guests. If you own an Airbnb business, you can act as a tour guide for them and show them around town. Be as creative as you want.
4. Adjust Your Rental Rates
Lastly, you can adjust your rates accordingly to achieve higher cash flow. It is a strategy that most Airbnb owners do. They adjust their nightly rates depending on demand and seasonality.
If you own a traditional rental, adjusting rates monthly will not work for you. However, you can do it as needed, such as in the case of fast-rising mortgage rates and inflation. Just make sure to let your tenants know in advance that you will need to make certain price adjustments.
Summing It Up
To sum it all up, learning how to come up with a proper and accurate rental property cash flow analysis will help you make informed business and investment decisions. As a real estate investor, you need to understand that the real estate industry is a numbers game. A slight miscalculation can be disastrous to you.
For this reason, we highly recommend using a website like Mashvisor, instead of a spreadsheet, for rental property analysis. Using Mashvisor will not only help speed up the process significantly but also increase your accuracy on cash flow projections.
Start using Mashvisor now to make cash flow forecasts. Sign up for a 7-day free trial of Mashvisor today, followed by 15% off for life.