(This advanced blog summarizes real estate investing tips and insights Lofty AI has acquired from working with thousands of investors and institutional funds.)
What is cash flow?
When you hear real estate investors use the phrase “mailbox money”, they’re referring to cash flow.
Cash flow is income generated when your rental returns exceed your monthly expenses.
It's one of the most popular rental property ROI calculations.
Cash Flow = total income - total expenses
For buy-and-hold investors, cash flow is king.
How to calculate rental property cash flow
Let's take a look at what goes into total income and total expenses below.
The total income will generally be the same as the total rent.
There are some cases where you're receiving income from application fees & laundry. But it's generally safe to assume total rent = total income.
There are plenty of expenses that you want to take into account.
It's better to expect the unexpected when investing in rental properties.
A few examples of potential expenses you should be thinking about:
- Property management
Example of calculating cash flow:
- John is looking to buy a home.
- His broker tells him that the home will rent for $1,350/month.
- She also says he'd be responsible for paying $50/month for garbage and $100/month for water/sewage.
- Based on her experience, John's broker knows vacancy rates in the area are 5% for the year ($50/month). She tells John to also allocate 10% each month for repairs ($120/month).
- John is also planning on setting aside 5% each month ($50/month) for capital expenditures. Capital expenditures includes anything from new appliances or a new plumbing system.
- He then calculates his mortgage payment at $500/month (taxes and insurance not included). The property taxes are $100/month, and the insurance would be $50/month.
- Finally, John will be using a local property management company. This company charges 10% per month to manage the property ($120/month).
How much cash flow, if any, can John plan to receive each month?
- $1,350/month (rent)
Expenses (per month):
- Mortgage: $500
- Taxes: $100
- Insurance: $50
- Repairs: $120
- Vacancy: $50
- Water: 50$
- Sewage: $50
- CapEx: $50
- Property management: $120
Add all these expenses up and it comes to $1,140 per month.
Remember, Cash Flow = Rent – Expenses
$1,350 (rent return) – $1,140 (expenses) = $210/month
This means that John will be receiving $210/month in profit from this rental property.
That's what we call positive cash flow or mailbox money. 🤑
How to increase your cash flow
The most straightforward way to increase your cash flow is to increase the rent you charge tenants.
This can be done by a few different methods:
- Acquiring an under-performing, mismanaged property that is charging a lower rent than the market average, and bumping up the rent to market rates.
- Renovating a property by adding new amenities like granite countertops and a new roof to bump up rents.
- Acquiring a property in a rapidly appreciating neighborhood allowing you to bump up rents as the area gets better.
Big-ticket repairs and maintenance expenses can take a drastic toll on your cash flow.
This is why preventative maintenance is so important. It's like insurance against potentially large expenses that may occur in the future.
A few examples include taking care of your HVAC units and trimming trees located close to your property. These big-ticket repairs don't happen often, but when they do you'll be happy you took the necessary preventative measures beforehand.
For a real estate investor, turnover and vacancy are two of the biggest cash flow killers.
Because of this, it's sometimes a good idea to have tenants that sign long-term leases so you don't have to worry about finding a new tenant.
The issue with this strategy is if you own a property in a neighborhood that is rapidly appreciating.
In that scenario, you might unfortunately sign a tenant to a 3 year lease at the same rent, when just a year-and-a-half later you would have been able to double rents because of growth of the surrounding neighborhood.
Appealing your property taxes
Property taxes can go up every year. If they increase faster than you’re able to raise the rent, you may run into a serious cash flow issue.
Depending on the market your property is located in, it may make sense to appeal your property taxes with the local government to potentially have them decreased.
Refinance your property
It is always a good idea to occasionally monitor mortgage interest rates. If you see that the rates are falling, you may be able to refinance and lower your monthly mortgage.
Naturally, this will increase your cash flow simultaneously.
Calculating cash flow using the 50% rule
The 50% rule is a back-of-the-envelope formula. Similarly to cash on cash return, investors use it to analyze a potential deal quickly.
The rule says that you should estimate your operating expenses to be 50% of your rental income.
If a rental property makes $50,000 per year in gross rental income, you should assume that half, or $25,000, will go towards expenses,
Only operational expenses, not mortgage payments.
The 50% rule is an estimate created by experienced real estate investors. It allows you to quickly compare potential investments to identify which properties will cash flow and which ones will not.
Keep in mind that this rule is based on assumptions that have yet to be verified.
We'll be discussing the 1% rule next.
What is the 1% rule?
According to the 1% rule:
For a $100,000 property to be considered a good investment, it must rent for $1,000/month or more.
1% rule formula = Monthly Rental Income ≥ One Percent of Purchase Price
The 1% rule is helpful for a few reasons:
- It helps you narrow a large list of properties into a smaller list of the best properties.
- It helps you determine if the monthly rent returns will exceed the monthly mortgage payment.
If the rent is only $500/month, the $100,000 price will not meet the rule.
Or if you had to pay $150,000 for a property that rents for $1,000, it would not meet the rule either.
Believe it or not, there's also the 2% rule...
The 2% rule states that a rental property is only a good investment if the monthly rental income is equal to or higher than 2% of the total price. Finding a property that fits the 2% rule mostly happens in areas like the mid-west and the southern US. Properties meeting the 2% rule can often become harder to find in more expensive cities like New York, Los Angeles & Boston.
What is a good cash flow for a rental property?
For a rental property to have good cash flow, it just needs to have positive cash flow. It's that simple.
Positive cash flow means your property's rent exceeds both operational expenses and mortgage payments. That's passive income baby.
Lofty AI’s cash flow calculator
This calculator works on any of our A.I.'s approved properties -- both traditional and short-term rental properties.
You're able to adjust the loan duration, mortgage APR, price, down payment, operating expenses, rent, vacancy rate, and much more.
Alongside our calculator, the Lofty AI real estate investing platform is constantly identifying properties that are undervalued and located within neighborhoods primed for rapid appreciation.
If you're interested in learning more, check out our website here.