Real estate is a game of numbers, and while it may seem overwhelming, there are some key metrics, like cash flow in real estate, that can assist you in analyzing and understanding the financial performance of your properties. These metrics can also guide you in determining whether it's appropriate to invest further and expand your portfolio.
Ultimately, if your rental property fails to generate the expected cash flow, it can hinder the overall growth of your business and you may need to take action to improve your portfolio profitability. Therefore, understanding and accurately tracking your rental property cash flow is critical in ensuring success in the real estate industry.
What is cash flow in real estate?
Put simply, cash flow is the movement of money in and out of a business. In terms of real estate, cash inflows or income could consist of received rent and pet fees and outflows or expenses could include taxes, maintenance costs, and other fees.
Positive cash flow is an indication that you are making more money than you are spending each month. On the other hand, negative cash flow is a sign that your rental is not currently profitable and you may need to take action.
How to calculate real estate cash flow
In order to determine whether a rental property is performing well financially, you’ll want to undertake a cash flow analysis. To calculate real estate cash flow you will need to subtract your expenses from your income.
Cash flow = income – expenses
For example:
Monthly rental income: $800
Monthly operating expenses:
- Mortgage: $250
- Taxes: $200
- Insurance: $50
- Water and trash collection: $80
- Maintenance costs: $100
Cash flow: $120 ($800 – $680)
After the expenses have been subtracted from the income, this property is left with a cash flow of $120 per month.
What is a good cash flow in real estate?
As a real estate investor, you are obviously aiming for a positive real estate cash flow. Ideally, your real estate cash flow should also be substantial enough to make your investment worthwhile. However, the actual cash flow figure will differ dramatically depending on the investment type, location, and your long-term strategy.
Generally speaking, cash flow of at least $100-$200 per unit can be considered good. This means that after all of the expenses have been taken care of the landlord will be left with this net profit. It can then be put towards further investment efforts or saved as security.
While cash flow is a relatively easy calculation to perform, it should not be taken at face value, as there are other factors that determine the overall financial health of a property.
For example, when analyzing rental property cash flow, the purchase price of the property should be taken into account. A property that was purchased for $100,000 but has a cash flow of $150 per month is very different from a property that was $800,000 with a cash flow of $150 per month.
Things that can negatively impact rental property cash flow
As careful as you are, there is sometimes no way to escape dips in your cash flow. Some of the factors that can harm your rental property cash flow are:
- Unexpected maintenance
- Unpaid rent
- Costly evictions
- Damage caused by tenants
- High vacancy rates
Depending on the severity of unexpected expenses, they may temporarily derail your cash flow. For example, a burst pipe in the middle of winter may incur a hefty maintenance fee. Similarly, although not the norm, nightmare evictions are still a risk that can result in one-off legal fees and unwanted vacancies.
Rental yield calculator
Alongside real estate cash flow, another useful calculation to have on hand is rental yield, which measures how much cash a rental property produces each year as a percentage of the asset’s value. Rental yield is unlike cash flow in that it does take the property value into account.
Landlord Studio’s free rental yield calculator will help you easily measure this.
How to increase real estate cash flow
If you find that your property is not bringing in favorable cash flow, you may be able to increase it in a number of different ways:
- Reduce vacancy rates: Vacancies can cost thousands in lost revenue. Having a process to find and keep great tenants is vital for mitigating losses.
- Increase rents: Adjusting the rent amount annually in line with market values, will help ensure you’re not leaving money on the table. Done right it will also help reduce vacancies.
- Renovate your property: Add value to the property through renovations that will allow you to charge a premium.
- Renting by the room: While renting rooms out individually takes more work to manage, for the right property it can also allow you to maximize income.
- Negotiate the terms of your lease: Your monthly repayments are likely amongst your largest expenses. By strategically negotiating the terms of your loan, you may be able to reduce these repayments to increase cash flow, or even lower your interest rate entirely.
- Create additional revenue streams: Whether it’s renting the garage or attached land separately, setting up billboards, pet fees, adding washing machines or vending machines, or something else, getting creative with your property could allow you to tap into new potential revenue streams.
- Reducing operating costs: Stay on top of your income and expenses with quality property accounting software, claim the maximum allowable deduction, and always be on the lookout for extraneous operating costs you can reduce.
Finding ways to maximize your rental income can help you hit those higher cash flow goals. Nonetheless, you should be reasonable in what you charge for rent, for example, to ensure your property remains attractive to potential tenants. If you live in a state or city that is rent-controlled, you may be limited by legislation.
If your current tenants are not pet owners, enforcing a pet fee and monthly pet rent will not lead to any discernable change. Adding a pet policy to the lease agreement during a vacancy, however, can lead to a widened pool of potential applicants and increased monthly income.
Finally, by adopting quality property management accounting software like Landlord Studio you can more accurately track your income and maximize your end-of-year deductibles. In a recent study, we found that investors who used software saved on average $500 more per property each year in deductibles than those that didn't.
Understanding how taxes affect real estate cash flow
Investing in real estate can yield significant returns over time, but it's essential to consider the IRS's share of the rental income you generate (reported on your Schedule E). When calculating cash flow for real estate investments, don't forget to account for the taxes you'll owe on that income. Typically, your net rental income is taxed at your regular income tax rate. If you fall into a higher tax bracket, this means a higher tax bill on your rental earnings.
However, you can offset some of your tax liability by deducting various rental property expenses, including:
- Maintenance and cleaning expenses
- Replacement of appliances or HVAC systems
- Mortgage interest
- Property insurance
- Property taxes
- Advertising costs
- Property management fees
- Homeowners association (HOA) fees or condo fees
- Utility bills
- Other services like pest control or landscaping
- Legal and professional fees (such as eviction costs)
- Vacancy-related expenses
Additionally, you can deduct depreciation expense on the property, further reducing your taxable rental income. Understanding your potential tax obligations related to owning a rental property provides a clearer picture of the actual profits you'll retain in the end.
You might like: Rental Property Tax Deductions Checklist
Using software to track rental property cash flow
Without consistently tracking your income and expenses, you will be unable to accurately calculate the cash flow of your rental property. Utilizing purpose-built property management software like Landlord Studio will allow you to keep on top of your bookkeeping throughout the year.
With accurate and up-to-date data you can run any of the 18+ reports to gain fast financial insights. For example, instantly generate a profit and loss report or Schedule E report to make filing an accurate tax return easy, or run a Trailing Twelve Month report monthly to review Net Cash Flow and identify opportunities for decreasing costs and increasing revenue.
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Final words: Cash flow in real estate
Keep in mind that every landlord has a different portfolio and different long-term objectives. A healthy real estate cash flow for one investor may be considered disastrous for another. How much cash flow is good for a rental property depends on the location, property type, investment strategy, and purchase price.
Many real estate investors are happy with cash flow of $100-$200 per month per unit, but this should be viewed within the wider context of your portfolio and financial goals.
The bottom line is that any positive rental property cash flow is good as this can lead to higher profit, increased opportunity for additional investment, and can act as a safety net, should unexpected expenses arise. If you are just breaking even without making any real gains, the investment may not be considered worthwhile.
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