What’s your cash flow?
There are many variations to the definition of cash flow in real estate investing. Ultimately, cash flow is the money you are left with in your pocket every month after settling all of your cash outflow requirements. If you are trying to grow a real estate portfolio, cash is king. If you are trying to buy one, maybe two properties to build long term wealth, cash flow might not be the most important requirement.
In summary: Cash Flow = Cash Inflow — Cash Outflow
Cash Inflow:
Let’s look at cash inflow first. The most significant source of cash inflow will be your rental income. I will use an example of a rental property I purchased in Windsor that we recently rented out. The property is a 3 bedroom single family residence home, being rented for $1800 a month.
Rental Income: $1800
Sometimes you have the option to earn income from other sources related to the home which are not directly rent. This could include:(i) Parking, (ii) Storage, (iii) Airbnb (Partial or Full), (iv) Solar Power (v) Property Related Services (ex, lawnmowing, house keeping/maid, landscaping) (vi) Charging more for a furnished unit, (vii) Advertising — more for apartment buildings.
Parking spots can go for $50–200 depending on your market, storage/sheds based on the size and accessibility can go for between $50–100, furnished units you can generally expect a +10% increase in rents, solar power revenue depends on your house and layout of the roof and advertisements generally work best on large multi family housing in metropolis areas.
In my case there was the potential to rent out a large shed for about $50 — $100 a month (not rented yet, so we will go with $50 a month).
Total Cash Inflow: $1850
Cash Outflow:
Mortgage:
The most significant cash outflow is your mortgage payment. A portion of this payment will be for the principal, while a portion will be for interest. While technically the mortgage principal payments help your equity build up, it is a relevant commitment to determine your cash outflow on a monthly basis. In my case, my refinance valuation was $250,000 resulting in a mortgage payment of $830.
Running total: $830
Property Taxes:
Total property taxes are $1767 per year. Generally you can pay the property tax on a monthly basis, this works out to be $147 per month.
Running total: $977
Home Insurance:
Home insurance can range quite a bit across various companies based on geographic locations, areas and types of homes that the insurance company specializes in. Shop around your rates, but you can generally expect to be at around $80 a month. In this case the home insurance expense is $76 per month.
Running total: $1053
Vacancy:
While this is not a cash outflow that occurs on a monthly basis, you shoud set aside some cash flow for when this occurs. Vacancy is the amount of time your house may sit unoccupied likely between tenants. You could also think of this as a buffer for any eviction related expenses that could occur. I generally set this range at 4% of rental revenue (assuming that for one month in a two year period, the house will be vacant).
Capital Expenditures & Repairs and Maintenance:
CapEx, Repairs and Maintenance will be required on your property. When tenants move out you generally have to at least paint, and for parts of a single family home this could be about $1,500. In addition you will eventually have expenses that are capital in nature: new roofs, new flooring etc. I generally take 6% of rental revenue out for this purpose.
In culmination, this is about 10% of rental revenue for vacancy, capex and R&M. The best way to do this is to take this out of your cash flow and move this into a separate account to build up your buffer. Therefore, this will be $180 a month.
Running total: $1233
Property Management: elaborate on this and explain why people need to buffer for this
Often when you are starting out in real estate you will feel like you can do the property management yourself and you do not buffer for it. However, your reality now and your reality in 4–5 years could be very different. Maybe you have been promoted at work and no longer have the time to manage the property and tenants. Maybe you no longer live in the city where you initially purchased the home. A slew of reasons could require you to bring in a property manager.
Property Management generally costs between 7–10% of rental revenue. In my case, my Windsor property management actually costs me $70 a month, which is well below the 7–10% range.
Running total: $1303
Property Management: elaborate on this and explain why people need to buffer for this
You are sometimes required to pay the utilities for your tenants. In this case, you should build in an assumption of $50 per tenant (individual) that will be living in your home. The property used for this example is a single family home rental. The homes are rented without utilities.
Running total $1303
Cash Outflow:
Determining your cash flow number allows you to calculate your rate of return and how the property fits in with your overall real estate goals. In addition, this cash flow is the buffer you have on hand in case you need to make rent decreases in a depressed economy. While I may be able to rent this house out today for $1800 a month, I know within the next 5 years if I ever need to, I can drop the rent to $1300 a month and still be able to carry the property. In the mean time, on top of my mortgage pay down and price appreciation, I earn a solid $500+ a month on a property where I am invested less than $5K. Not too bad!