There are many metrics of success for rental properties. Cap rate and rate of return calculations can help new real estate investors determine success. In addition, cash flow on rental property is another critical way to ensure investments are driving a positive return over time.

One of the first questions every new investor should ask is: “how much cash flow is good for rental property?” By understanding how cash flow works, you can determine how to find the best opportunities and measure which real estate options align best with your goals.

What is Cash Flow?

There are two types of cash flow on rental property investors need to understand. Gross cash flow measures the full rental income per month, while net cash flow is the amount of money after expenses.

In simple terms, gross cash flow is all the money that comes in from tenants. This includes the rent along with any additional fees charged, including late payment fees or service fees.

Net cash flow is the money collected from investment real estate every month after all expenses are considered.

How to Calculate Cash Flow

Calculating net cash flow for a rental property starts by considering all of the operating costs the investor must incur. This includes:

· Mortgage payment,

· Taxes,

· Insurance payments

· Homeowners association dues

· Contributions to your capital expense account to cover repairs

· Maintenance

· Any other expenses related to the property

From there, you can calculate by subtracting the gross income from the expenses. In most cases, the final number will be positive, which indicates passive income the investor can build upon over time. On the contrary, investors may face a negative cash flow if their expenses exceed the gross rental income, or if the property remains unoccupied for a long period of time.

How Much Cash Flow is Good?

When considering cash flow on rental properties, there is no single right answer for every investor. Instead, finding the ideal cash flow number is dependent on an investor’s personal goals and long-term investment strategy. Two ways to determine your target cash flow on an investment property are by calculating return on investment or the cash-on-cash return.

Using return on investment considers how much a property could make over the course of a year, based on the cost of the property. For example: if you purchased a bank-owned home for $125,000 and can get a net cash flow of $10,600 every year, your effective return on investment is 8.5 percent. As a general rule, a rate of return over 8 percent is considered exceptional.

With cash-on-cash return, investors divide their net cash flow over how much they have invested in the property.

Here’s an example: An investor buys a home at a foreclosure auction for $100,000. In the first year, they will pay a $10,000 down payment, $800 per month in mortgage payments, and save 5 percent of the gross cash flow for capital expenses.

With everything paid, their net cash flow would be $3,900, for a cash-on-cash return of 33 percent. Considering most investors target at least a 10 percent cash-on-cash return, this property could represent an incredible opportunity.

Using the 1% Rule to Calculate Gross Cash Flow

Before making a bid on any real estate property, it’s important to figure out how to calculate projected cash flow ahead of the purchase. One way to make a smart estimate is by using “The 1% Rule,” which suggests the gross monthly rent needs to be at least 1 percent of the purchase price.

As an application of the 1% Rule: An investor can buy rental real estate for $130,000. Under the 1% Rule, the rent should be at least $1,300 per month. If the rent is below that number, it could result in a weaker cash flow because the home prices are inflated, or the average rent is below market value.

Although the 1% Rule shouldn’t disqualify an investment opportunity, it should give investors reason to pause and determine how they can increase cash flow if they buy.

How to Increase Cash Flow

There are several ways investors can improve their cash flow on rental properties both as soon as they make a purchase decision, and throughout the life of their ownership. It all depends on how they manage their real estate and how they improve it.

Creating a positive cash flow over time starts with finding the right tenants. Before renting any home, owners should carefully screen potential occupants to ensure they are low risk. This includes running background and credit checks on applicants to pinpoint the best renters.

If investors experience difficulty in pricing rent or finding tenants, partnering with a property management company can help them make smart decisions about the local market. The right group can give investors confidence on how to cash flow rental property through screening tenants and maintaining homes through a wide network of service providers.

Finally, cash flow can increase as a result of implementing certain upgrades. Amenities like energy-efficient appliances or modern in-home finishes can attract potential renters and fetch a higher rent price.

Other Features of a Good Rental Property

Of course, home features and real estate markets aren’t the only situations that can affect cash flow on rental properties. When evaluating a potential real estate investment, consider the following factors:

· Local dynamics, like school districts, hospitals, and crime rate, can ultimately affect property values and the rent owners can ask for. This data can ultimately make or break your return.

· The larger real estate market can also dictate the cash flow of rental properties. Two-year job growth numbers, planned housing developments, and census data can help investors project their rate of return over time.

· Community amenities can also affect cash flow. Access to shopping centers, community parks, and public transportation can make some rentals more attractive than others.

Things to Consider

Although both the return on investment and cash-on-cash methods can help buyers make an educated decision about diving into real estate.

Everyone needs to go into a buying decision with their eyes wide open. Even if these methods can help project success, investors need to be smart about making a purchase decision.

Before trying to calculate cash flow on rental property, investors need to do their due diligence on real estate. When researching a property for sale, every buyer should understand the home’s condition, what liens are on the property, and how the price compares to other lots in the neighborhood.

Moreover, local real estate dynamics can affect cash flow of rental property. Before making a purchase decision, every investor should research the supply and demand of rental units, the average rental price, and average occupancy term. If an investor buys a rental property in a market that is oversaturated or has a higher entry cost, your cash flow could be severely affected – or even go into the negative.

Conclusion

Before considering buying a rental property, smart investors think about how to cash flow rental property. Projecting returns early from community factors can create long-term wealth and passive income for the best buyers.

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