Like business, cash flow is very important for a real estate investor. You need to understand what positive cash flow is and how to calculate it when investing in a rental income property. If the difference between your earnings and expenses is positive, you can breathe easy as your property is enjoying a positive cash flow.
Income should be more than operational expenses
In real estate, if a property is earning an income higher than is spent on its maintenance and upkeep, it is referred to as a positive cash flow property. Such properties are helping large numbers of investors to earn profits from their investments. In a rental income property, income is invariably the aggregate monthly rent paid by its tenants. On the other hand, expenses are repairs and maintenance of the property. Taxes and insurance constitute another category of expenses.
There are two ways of obtaining a positive cash flow from a rental property. You can either increase the monthly rent or try to reduce the operational expenses of the property.
If you are interested in buying a property, it is important for you to find out whether it is generating positive cash flow or not. For this, you need to know its gross income as well as operating expenses. Gross income is usually the sum of monthly rents paid by individual tenants. On the other hand, operating expenses refer to all the expenses that you incur on the maintenance and operation of the property. When calculating operating expenses, you also need to consider vacancy of units. For example, if there are 10 units rented out at $1000 per month, vacancy of 10% means one unit remaining unoccupied. You need to add $1000 to your operational expenses to accommodate for the loss of income.
Once you have calculated your operating expenses, you need to subtract them from the gross income to find the net operating income. This statistic tells you how much money you can expect to earn from a rental income property on an annual basis.
Finding cash flow of a rental income property may be a tedious job provided you have to keep track of lots of numbers and then do simple math to get down to cash flow. Even a small mistake here and there can lead to getting a figure that is incorrect. Acting on behalf of this figure can be foolhardy for you as an investor.
Knowing cash flow condition is essential for a sound investment
Despite inherent difficulties in calculating cash flow from properties, you cannot expect to buy a property without knowing about its cash flow condition. The first step towards this objective is to find out properties that are generating high amount of income in comparison to their listing prices. This allows you to compare different rental income properties and choose one that is just right for your real estate investment.
Buying a property in a remote location just because it is available at less than its fair market value is not a good decision for any investor. Similarly, do not fall in the trap of a seller who promises high occupancy in his property just to sell it to you at a high price. After buying, you realize that many of your tenants are fake and squatters who will not pay any rent to you.
It is not worth buying a property until you are sure that it has a good income earning potential and its operation and maintenance involves lesser amount of money than income. If you fully understand the concept of positive cash flow and the formula to calculate it, you can take better informed decisions as a real estate investor.