How to Calculate Positive Cash Flow on Rental Property

Calculating the costs and checking it twice. Calculating the cash flow and the best rental price.
RThe best time to determine whether or not a property will positively cash flow or not, is before you buy it. However, if you already have the property, then managing the costs and the rental price can go a long way to making that property positively cash flow.The idea of investing cash today is to ensure greater returns later than if that cash stayed in your drawer for the same period of time. This financial concept is often referred to as cash on cash return. The greater the return on the cash invested, the better the investment. Positive cash flow (not future speculative returns) is the more effective way to invest in real estate. Knowing how to calculate that cash on cash return is key to extracting profit from that investment.

Instructions



Step1Gather all property specific information that contributes to costs or expenses on that property.Purchase price, deposit information, closing costs, taxes, insurance and maintenance are just some of the information that must be collected up front in preparation for the cash flow calculation. If the property is being researched for purchase feasibility, then ask the seller to provide proof of all information submitted, such as copies of bank statements for at least three months, receipts and so on. If the property is already owned then find all the pertinent information and have it on hand to plug into the calculation.
Step2Gather all the property specific information that has or could contribute to an income from the property.Rental income, the number of existing active leases and onsite vending machines are just some of the income generating opportunities investment property offers. Scrutinize seller offered information for validity. Sellers may often inflate income promises to encourage the sale, so do due diligence to verify their claims. Property already purchased with no prior rental history or poorly managed rentals may have hidden potential for generating income. Curb appeal, comparative features and effective marketing can bring in top rental dollars and other potential income streams.
Step3The formula is: GPI - VAC = EGI+OI=GOI-OE=NOI-RRA-DS=BTCF Cap Rate = NOI/Purchase PriceCash on Cash Return = BTCF/Down PaymentGPI - Gross Potential Income. This is the rental income received for all the units for a yearVAC - Vacancy and Losses, usually calculated at 5% of GPIEGI - Effective Gross IncomeOI - Other income, such as vending machines, income from late fees, coin laundry, copy/fax services, and so onGOI - Gross Operating IncomeOE - Operating ExpensesNOI - Net Operating IncomeRRA - Replacement Reserves AccountDS - Debt Service, better known as the mortgage paymentBTCF - Before Tax Cash Flow
Step4Review the sample property, then plug your own numbers in. The sample property is a Duplex with two one-bedroom units. This was purchased brand new with no prior rental history. The short sale purchase price was $65,000 with a 10% deposit of $6500. There are no vending machines or coin laundry onsite, the owner self manages the property and does most of the maintenance. Going rental rates in the area for one-bedroom apartments range from $350 to $450 per month. The mortgage payment is $470/month, 9% interest fixed for 30 years.Cash put into the property: Down payment................................................... ....$6500 Closing costs..........................................................$3000 Repairs - property is new.....................................$ 0Total cash invested....................................................$9500Income AnalysisGPI.........$350 per month x 12 months x 2 units....$8400(-) VAC (5% of GPI)....................................................($ 420)= EGI..................................................................$7980+ OI.................................................................................$ 0= GOI..............................................................................$7980Operating Expenses Property taxes and insurance....................$2500 Supplies and repairs..................................$ 150 Utilities and garbage.................................. $ 0 paid by tenants Legal and marketing...................................$ 500 Landscaping.................................................$ 360 Owner maintains landscape Property Management fee...........................$ 0 Owner manages propertyTotal Expenses OE....................................................$3510Cash FlowGOI.................................................................................$7980(-) OE............................................................................($3510)= NOI............................................................................$4470- RRA (6% of NOI)....................................................(.$ 268)- DS (Mortgage 30 years @ 9%)............................( $ 470)= BTCF..........................................................................$3732Cap Rate (NOI / Sale Price) $4470 / 65000 = 6.9%Cash on Cash ReturnBTCF / Total Cash Invested $3732 / $9500 = 39%This scenario shows this investor positively cash flows and has earned a very nice return on the invested capital.
Step5Have older properties inspected to determine potential hidden short and medium term expenses, such as roof replacement and problems with structural integrity that may not be obvious to the untrained eye. Regular upkeep expenses must be budgeted as well as unexpected repairs or replacements. Maintenance is the one area that causes tenant complaints and budget surprises so pay close attention to this area. Prevention is cheaper than cure, so ignoring this will negatively impact the bottom line.