Whether you’re a seasoned investor or just starting, understanding cash flow is critical to making informed decisions in the world of real estate. It can be the determining factor if a property is a good deal or a bad deal. If you don’t know if your property is going to cash flow before you buy it, then you are taking a huge unnecessary risk. I’m going to help you understand cash flow in real estate investing and what all goes into determining your cash flow on a property.
First, let's define cash flow.
Cash flow is the money that is coming in and going out of your real estate investment. It is the difference between your rental income and your expenses. Positive cash flow means you’re earning more money than you’re spending, while negative cash flow means the opposite. You need to know how to calculate your cash flow on a property so I’m going to tell you how to do that as well.
Positive cash flow is important for several reasons. It helps you generate income from your investment, which can be reinvested or used to pay off any debts associated with the property. It also helps you build equity over time, which can increase the value of your investment. If you have a negative cash flow, not only are you having to pay out of pocket every month just to hold onto the property but you might lose the property too if you can’t pay the mortgage on your investment property because you were wanting to use the rental income to pay off the mortgage and you didn’t have any cash reserves.
Now that we understand the importance of cash flow, let's look at some ways to calculate it. There are two types of cash flow you should know about: pre-tax cash flow and after-tax cash flow.
Pre-tax cash flow is calculated by subtracting your expenses from your rental income. Expenses include mortgage payments, property taxes, insurance, maintenance costs, and property management fees. Pre-tax cash flow gives you a good idea of the income generated by your investment, but it doesn't account for taxes.
After-tax cash flow is calculated by subtracting your expenses and taxes from your rental income. Taxes can be a significant expense for real estate investors, so it's essential to calculate after-tax cash flow to get a more accurate picture of your investment's profitability. A lot of the time whenever you are buying real estate, your tax write-offs will cross out your taxes you will owe. But that’s a topic for another blog.
When calculating cash flow, it's important to take a long-term view of your investment. Cash flow can vary from month to month, but you should aim for positive cash flow over the long term. You should also consider the potential for appreciation in the property's value, which can provide a significant return on your investment over time.
Now let’s talk about the benefits of positive cash flow. As we mentioned earlier, positive cash flow can help you generate income from your investment, build equity, and increase the value of your investment over time. It can also provide a cushion for unexpected expenses, such as repairs or vacancies. Positive cash flow can also help you qualify for financing for future investments. Lenders are more likely to approve loans to investors with a proven track record of positive cash flow.
Now, let's discuss some factors that can impact your cash flow. The first factor is your rental income. The amount of rent you charge can significantly impact your cash flow. Setting the right rent amount requires careful consideration of the market conditions, your location, and the features and amenities of your property.
Another factor that can impact your cash flow is your expenses. It's essential to carefully track your expenses and look for ways to reduce them. For example, you can reduce your property management fees by managing the property yourself or hire a property manager who charges lower fees.
The third factor that can impact your cash flow is vacancies. Vacancies can be a significant drain on your cash flow, as you won't be generating rental income during that time. To minimize vacancies, it's important to market your property effectively and provide a high-quality living experience to your tenants.
Finally, let's talk about the role of financing in cash flow. Financing can impact your cash flow in several ways. Your loan payment is one of your most significant expenses, so it's essential to choose a loan with a favorable interest rate and repayment terms. You should also consider the length of the loan term and the potential for prepayment penalties.
Understanding cash flow is critical for real estate investors. Positive cash flow can help you generate income, build equity, and increase the value of your investment over time. I know a lot of us are visual learners so if you want me to break everything down for you and show you exactly, step by step how to calculate your cash flow, so click on the video below to watch me do everything step by step for you.
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