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What is Cash flow for rental properties?

What is Cash flow for rental properties

Cash flow for rental properties refers to net cash in and out of a rental property.
There are two types of cash flows i.e. cash inflow and cash outflow. Where, cash inflow is the cash received and cash outflow is the total expense.

According to Tim Vipond, author of ‘Cash Flow – Overview, Types and Uses’, cash flow
is an increase or decrease over the span of time. Some property managers focus on annual cash flows, however, some opt for monthly cash flow calculations.

How to calculate cash flow for a rental property?

Cash flow calculations can be done using the following formula:

CF = CIF – COF

CF: Cash Flow

CIF:Cash Inflow

COF: Cash Outflow.

Cash outflow may vary from place to place, depending upon the type of property, rental policies, regulations, utility bills, operating expenses etc. On the other hand, cash inflow is rental income. Where, rental prices may also vary from property to property depending upon the locality, access to commercial area, parks etc. 

For more clarity, let’s work out with one example. Suppose, we have a rental property in Calgary, USA. The only rule of thumb in calculating cash flow is to differentiate the cash outflows from cash inflows. Following is the cash flow breakdown:

Table 1: Cash Flow Example

Cash Outflow

Cash Inflow

Property Taxes

– $ 255*

Monthly Rent

$ 2,400**

Mortgage Payment

– $ 310

  

Utility Bills

– $ 250

  

Property Insurance

– $ 80

  

Maintenance Cost and Operating Expenses

– $ 70

  

Capital Expenses

– $ 50

  

Total Cash Flow

$ 1,385

* Negative sign means cash outflow

** Positive signs means cash inflow

What is cash flow positive rental?

Cash flow positive rental means that the cash inflow is greater than the total cash outflows. From real estate investors point of view, the cash flow shall always be positive. Moreover, rental strategy and investment strategy play a vital role in cash flow.

Minimizing the expenses and maximizing the annual income leads to positive cash flow. Negative cash flow is opposite of positive cash flow. Real estate investors try to avoid negative cash flows in order to keep adding investment properties in their portfolio.

 

How Much Cash Flow is Good For a Rental Property? 

As per data from research by Gavin Donnelly, author of ‘How to Calculate Average Cash Flow on a Rental Property’, rental property owners and rental property investors aim for cash flow of 10% of property’s purchasing price per year. This is known as a 10% CASH ON CASH return.

In the 2024 market, a 10% cash on cash return is hard to get, and typically, it will not happen out the gate. The rents on a property will need to be slowly increased over time, and then, after a few years, perhaps the return will be up to a 10%.

But remember- even if the property is not kicking off a 10% cash flow return, it is still appreciating in value, and still providing many tax deductions and benefits. The cash-on-cash return, or cash flow, is simply the cherry on top.

 

What items can decrease cash flow in a rental property?

There are hidden items which can decrease the cash flow in rental property are:

Heightened Utility Costs

Utility costs can be estimated, but some things which hit people unexpectedly:

-If any utility is not separately metered, the tenants cannot pay individually; landlord has to pay those, and then, has to figure out a way to charge it back to tenants. This is cumbersome, but doable.

-If there is extreme hot or extreme cold, gas and/or electricity can spike way up beyond expectations during times of inclement weather;

Utility costs are included in normal operating expenses. As the utility costs increase, the net cash flow decreases.

Property Management

Rental property owners can hire property managers to oversee their real estate investment property. Property management will reduce your operating income but will help reduce your vacancy rates. Lower your vacancy rate will help your return on investment. Real estate investors have to pay monthly property management fee. As per facts and figures presented by Ben Luxon, the author of ‘Common Rental Property Maintenance Expenses: How to Estimate Maintenance Costs’, property management fee may vary from 6% to 12% of monthly rental rate. However, real estate investors can also choose one-time fee policy. 6-12% off the top of the rents, eats way into rental return. Property management must be chosen carefully, or, if investors are in a position to self-manage, that might also be a good idea. With automation methods and software platforms now available, most small landlords can self manage. We believe that, if you own 10 or less units in the same geographic region (easy driving distance), then there is no reason to be paying property managers.*

Maintenance and Repairs

Maintenance and repair costs are random and unexpected costs. Due to the randomness, rental property owners cannot foresee these expenses.

Maintenance and Capital Expenditures (Cap-X) costs include:

  • Seasonal Maintenance
  • Home Service and Cleaning
  • Appliance Maintenance or replacement
  • Electric or plumbing repairs, large or small
  • Painting/cleaning/turning units
  • Property Renovation and updating
  • Sewerage Management and major repairs etc.
  • Vacancy Costs
 

Investors must always remember that, the property is going to have vacancy, delays between tenancies, etc. Typically, investors calculate that 5% or so of a properties income is lost to vacancy, so vacancy is often put on the balance sheet as a 5% expenditure. (Even though it is not really an expenditure; it’s money that is lost because it never comes in, but it is treated as an expense on the balance sheet or rental calculator)

Property Operational Costs

Property operational costs include:

  • Salaries and wages 
  • Supplies
  • Legal fees, bookkeeping fees, accounting fees
 

For smaller properties this is not significant, on larger ones, these costs can add up.

 

Property Tax

Profits are greatly affected by high property taxes. It is very crucial to understand the country’s tax policies before purchasing the rental property. Taxes can change from one part of a city to another, and vary in ways that are hard to figure out. Speak to your realtor and/or a tax professional, about exact property taxes for any given property. Typically, 1.25% of the purchase price of a property, per year, is the amount of tax an investor can expect to pay in CA.

How do taxes affect real estate cash flow on a rental property?

Taxes can decrease real estate cash flow on a rental property. It depends upon the type of property, place and the amenities. Local municipality authority decides these taxes. Real estate investor has to pay property tax while purchasing the property. One-time policy can also be applied however, investor may pay property taxes on monthly basis.

 

What Is the Average Cash Flow on a Rental Property

Average cash flow on a rental property purely depends upon several factors, like, where your property is, what is it’s worth, nearby landmarks etc.  According to Marta Lukawski, author of ‘Unlocking the Secrets to Successful Rental Property Cash Flow Analysis’, average cash flow for a rental property is around 7% to 8%.

However, the definition of average cash flow or good cash flow is different for every rental property owner and real estate professional, and every market.

In a high appreciation market, cash flows tend to be viewed as less important, because the true value is in the property appreciation; the cash flow simply allows the investor to hold onto the property long enough to get the massive appreciation value.

In a lower appreciation market, cash flow tends to be viewed as far more important, and indeed can be the entire motivation for the real estate investment in the first place. In these markets, investors are going to demand, and rightfully so, bigger cash flows. 

Even still though, the cash flow for the first year(s) may not be very high, and the investor may need to wait for rents to appreciate/catch up.

Why Are Positive Cash Flow Investment Properties Important?

For stable real estate business and real estate market, positive cash flow investment properties are very important. Positive cash flow investment properties’ capital price increases with time. It helps the real estate investing business to attract more real estate investors which leads to growth of real estate industry and country as a whole. 

However, positive cash flow investment properties attract seasoned investors who are looking for passive income, as real estate investment has proved to be one of safest investments. 

And in addition to passive income, cash flow simply allows landlords to keep properties, rather than let them go. If a landlord is losing money on a property each month and cannot manage to make it pay for itself, the landlord will likely have to sell the property, and thus, not benefit from the appreciation the landlord would have had if the landlord could have held on. 

Many view cash flow not as the ultimate goal, but merely as the vehicle by which investors are able to hold onto properties long enough, that massive appreciation can be realized.

 

How to Find Positive Cash Flow Properties for Investment 

Cash flow calculation is the first step towards finding positive cash flow properties for investment. It depends on one’s financial goals that how much one expects positive cash flow. Here are the steps to find positive cash flow rental properties for investment:

  1. Research about tax policies and rules
  2. Select the area wisely
  3. Calculate cash flow of rental properties
  4. Look for properties in areas where the prices are not very high, versus the rents. These are typically not going to be “A-Class” areas.
 

How to increase rental property cash flow and increase rental income?

Selection of investment area matters a lot. However, rental  income can be increased by decreasing:

  • Utility expenses
  • Maintenance Costs
  • Operational Costs
  • Repair Costs etc.
 

What is the difference between Cash flow and IRR?

IRR (Internal Rate of Return), calculates how profitable the investment is. IRR is the discounted rate at which, the net present value (NPV) becomes 0.

Cash flow involves both positive and negative cash flows. So, if cash flow becomes positive, then turns negative and then again become positive, IRR may have multiple values. Furthermore, if all cash flows are positive or negative i.e. cash flows have same signs, we cannot find rate for which NPV is 0. 

 *: Exception, there are liability reasons for using property managers. If an injury happens or some other problem happens at the property, the property manager will be the first person or company to be held accountable; landlord will likely not be held responsible because landlord was not in charge of properties condition. If landlord is self-managing, then landlord can be blamed for anything that happens as a result of landlord’s negligence/neglect.

 

If you would like more information about cash flow for rental properties, contact Big Town Real Estate.

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