Calculate Cash flow by Working Backwards from the Rent

Property Management Blog

Calculating actual cash flow form a rental income property is crucial in making sure your purchase turns out to be fruitful. This exercise tells you whether a given property is worth the price that is being asked by the seller or not. This calculation is also useful in arriving at an asking price for a property in which you are interested. Calculations shown in this article are based on properties situated in Memphis, Texas, an area where rents are high but so are the prices. This one is a duplex for which the asking price is $195000.

By doing some research, you find that units of this duplex will fetch a monthly rent of $750 to give you a monthly rental income of $1500. This is a figure that you must use backwards to know whether investing in this property is good for you or not. Duplex properties in this area are assessed for tax at a rate of 40% if they are non-owner occupied and at a rate of 25% of, they are occupied by the owner.  Thus, you find out that you will have to pay $4250 per annum as tax if you buy this property. This turns out to be $350 per month.

Another expense as the owner is the insurance premium you must pay. If you consult your insurance adviser, you will learn that premium for this property would be $480 per year. There are other expenses also, each accounting for 10% of your monthly rental income. You can expect to spend $150 per month on maintenance, reserves, and vacancy. Deducting all the expenses, you find that you are left with

$1500- ($350+$30+$150+$150+$150) = $660.

Likely, you have not used your own $19500 for buying the property. If you have availed a mortgage, you will also need to deduct the principal and interest you repay to the lender every month from your monthly rental income. If you have borrowed money at 4.7% rate of interest for a 30-year mortgage, your monthly repayment would be $830.

This calculation shows you are receiving a negative cash flow if you buy this property.

Let us check out cash flow for a duplex property for which the owner has asked you to make an offer. For the purpose of calculation, let us take the monthly rental income as $2000 for this property. If you do the same analysis of cash flow working backwards, you find that you can expect a gross monthly rental income of $960 from this property. This means you are getting a positive cash flow of more than $200 per month after deducting the expenses on principal and interest repayment on your mortgage. But this is still not enough to earn you any kind of net profit for looking after the management of a property. As such, it is prudent that you do not give an offer of more than $175000 to the owner of this property. If you can secure this property, you can expect a positive cash flow of more than $200 per unit per month from this property. It is better to start with an offer of $150000 and if the owner does not accept it, make sure you do not go beyond $175000 if you are desirous of making a positive cash flow from your investment.

A good deal is not that easy to find

You have now learnt how to work backwards form the gross monthly rental income to arrive at the cash flow form a property. You can use this figure to check if the property is worth that much or not and to make an offer for a property to ensure positive cash flow. Just remember that these examples do not consider any money that you may be required to spend on repairs.

If you’d like to talk more about property management, or you need help with Everest Property Management, please contact us at Everest Realty. 

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