An essential concept aspiring landlords and real estate investors need to grasp before diving into rental real estate is how to calculate rental property cash flow. After all, cash flow is the lifeline of a rental real estate business. Luckily, calculating cash flow is easier than you might think.
Learn the process of calculating cash flow for a rental property so you can focus on acquiring investment properties with good cash flow while avoiding the properties that eat into your net profits.
What is cash flow?
In real estate, cash flow is the difference between a property's income and expenses including debts. Cash flow is used in properties that produce income, like rental real estate such as an apartment complex, single-family rental, duplex, or commercial building.
A property can have positive cash flow, where there is more income than expenses and financing costs, or negative cash flow, where the expenses and financing costs exceed the income and the landlord loses money each month.
Most real estate investors aim at owning rental property with positive cash flow. The more cash flow a property has, the better the return and the more income the real estate investor earns. Having higher cash flow also provides the landlord with a safety net for when unexpected expenses arise like a burst pipe, roof replacement, or new A/C or furnace. The more cash flow you have, the more you are able to sustain your business expenses, especially in economically challenging times.
How to calculate cash flow
Calculating a rental property's cash flow is a relatively simple process:
- Determine the gross income from the property.
- Deduct all expenses relating to the property.
- Subtract any debt service relating to the property.
- The difference is the property's cash flow.
The gross rental income of a property is the total income from all sources before any expenses or mortgage payments are made. Some properties, like a single-family rental, will only have one source of income, the rental income. But certain rental properties, especially commercial property, may have additional income streams like on-site laundry, late fees, pet fees, or product sales like boxes or moving supplies.
Expenses relating to a property will differ by the property type. Commercial properties that have net leases may have fewer expenses than a residential rental property that uses a gross lease.
Calculate what the property's expenses will be to maintain that specific property. You can use the seller's expenses or you can estimate to get a rough idea of the cash flow for the property. Expenses can include the: