Many investment ventures have a common goal — to get more money out than what was put in. Real estate investing is no exception, but it’s also an opportunity to expand your portfolio or create an additional income stream. The first step towards creating income through real estate is to invest in rental properties that generate a positive cash flow – properties where more revenue is coming in than going out every month.
Keep reading to learn more about cash flow, including how to increase it, how to calculate it, what’s a good target to aim for and more.
What is cash flow?
Cash flow is the net amount of cash that is transferred in and out of a business. Money received is an inflow and cash spent is considered an outflow. Companies’ goals are to generate positive cash flow, which comes from more cash coming in than is being spent.
When it comes to real estate, cash flow relates to how much money a rental property generates versus how much money is being spent on it. Just like with any business, positive cash flow may be a real estate investor’s target because it shows they’re making money off of their rental property or properties. A positive cash flow can provide real estate investors with more funds to maintain, repair and market their buildings.
Negative cash flow occurs when a rental property investment is costing a real estate investor more money than it’s generating. This could happen because of unforeseen repairs, unit vacancies and more.
Whenever terms like “money earned versus money lost” are used, it’s easy to think about profit. Cash flow and profit are not the same thing, however. Cash flow measures how much money is coming in and going out of an investment property or business. Profit, meanwhile, measures how much money a business made — the amount of cash that’s left over after all bills have been paid and other financial obligations have been met.
What is the average cash flow on a rental property?
There are several factors that can impact a rental property’s cash flow, which makes it difficult to pinpoint an “average” cash flow. For example, where is the property located? This will have a significant bearing on how much cash flow it can generate. Location can dictate the cost of certain expenses like property taxes, and if your property is in an area with rent control laws, there could be a limit to how much you can charge tenants.
The type of investment property you own will also factor into your potential cash flow. A multi-family property will allow you to collect rent from a number of tenants, while a single-family home would yield just one rent payment a month. Also, how much did your real estate investment property cost? The more expensive it is, the better chance you have at a higher monthly cash flow, as you’ll be able to collect more rent. Less expensive, suburban-based properties likely would not fetch as high of a rent and would produce lower cash flow.
So, while these factors, among others like your rental strategy and property amenities, make it hard to gauge an average cash flow, the figure is typically an 8% return on investment, according to landlord insurance provider, Steadily. Again, this is the average, so many other real estate investors may be aiming for a much larger cash flow ROI.
What is “good” cash flow on a rental property?
Average cash flow on a rental property can be tough to determine because there are so many factors at play, but “good” is a little easier to measure as it’s in the eye of the real estate investor. If you feel your rental property’s cash flow is “good”, then it’s good.
To be a little more specific however, if you’re looking to turn a profit, a positive cash flow is good and the more cash flow you have the better your property is performing. Every dollar that you can put in the “plus” or “inbound” column is another dollar you can invest back into your property, use to purchase another one or simply just put in your bank account.
There are several rules real estate investors are advised to follow to generate a “good” cash flow. One is to shoot for $100 to $200 in cash flow for every unit you purchase. So, if you have three units, you want to see at least $300 in cash flow. Own a six-unit building? Aim to make $600 minimum.
However, the “per door” rule has its limitations. If you invested hundreds of thousands of dollars in a rental property, you might want to see more than $100 in cash flow per unit. That’s why it’s important not to look at any one particular rule as a measuring stick for what constitutes good cash flow for your rental property.
The “1 percent rule” is another common one among rental property investors. It helps them determine a property’s cash flow potential quickly. The way it works is a property’s rental income should be at least 1 percent of its purchase price. For example, if you purchased a rental for $100,000, the total rent should be $1,000 minimum. If a property does not meet this standard, it’s not likely to yield positive cash flow and you may want to consider another property to invest in.
Just like with the cash flow per unit rule, this one should be used as a guide rather than an absolute for determining good cash flow. There’s always the chance that a property meets the 1 percent rule threshold when you first acquire the property, but eventually can’t meet that bar. Don’t just look at the building’s current monthly rent price, study to see how the property will perform going forward so you can see if it will continue to give you good cash flow. This includes examining how much your investment will appreciate over time.
How do you calculate cash flow on a rental property?
You’ll need some important details about your rental property to calculate its cash flow. These include gross income, total expenses and debts associated with the property (if any).
For example, your gross rental income is money your property generates prior to expenses being deducted. Rent is a primary income source. Various fees you charge, such as for the tenant to have a pet or date payments, could also contribute to your rental property’s gross income.
Once you’ve accounted for your income, take a look at your expenses. These could include property taxes, insurance, repairs, utilities and property management fees if you hired a company to take care of your property for you. The building’s vacancy rate should also be considered an expense because any empty units are not generating income.
Now that you have your income and expenses figured out, subtract the latter from the former to calculate your rental property’s net operating income (NOI). This figure represents your cash flow. If you assumed any debt (i.e. any financing you took on to purchase the property), subtract the amount from the NOI to get your true net cash flow.
How to potentially increase cash flow
Whether you need to increase your rental property’s cash flow to make your investment worthwhile, or you want to make your good return great, there are plenty of ways to do so. In fact, even if you’re happy with your property’s financial performance it’s still good to know how to increase your income. You never know when your units could sit vacant for several months or if you’ll have to make a burdening repair that may offset your inflow.
Here are a few ways you can increase your rental property cash flow.
Add new amenities
Prospective tenants will do their homework before signing a lease and that includes examining what rental properties have to offer. You can make yours more enticing by installing “must have” appliances such as a dishwasher or washer and dryer. Yes, this will cost you more upfront, but you can make up the difference by charging more rent, which tenants will likely be willing to pay for the convenience of having these appliances on site.
Speaking of paying more rent, an increase can help you create more positive cash flow, too. Be sure to do some research before making this change though. You don’t want to raise rent significantly above what rental properties similar to yours in the area are charging for example. Otherwise, tenants might start looking at those buildings when their lease with you expires. It’s also best not to make rent increases during the holiday season when tenants might have additional expenses.
Charge for parking
You could create an additional revenue stream if there’s limited parking around your property. Charge tenants (or others) a monthly fee to park their vehicles in your property’s spaces. Or, if your rental has a garage, you can charge tenants to use it, rather than making it a free amenity.
Keep your tenants happy
This step might not generate cash flow, but it could keep you from losing some. Happy tenants often stay put. When they do, you don’t have to worry about vacancies, which can lead to lost revenue for months on end. Replacing tenants doesn’t just cost money, but time. You have to advertise, screen the prospective tenant, write up a new lease, prepare the unit for your new tenant and more.
Being upfront with your tenants about rent, providing useful amenities and fulfilling maintenance requests in a timely manner can all go a long way towards high tenant retention.
Claim tax deductions
Property taxes are likely one of your largest expenses to pay for your rental. Claiming tax deductions can help lower your overall costs. Repairs, insurance and property depreciation are just a few items you can claim. Check your local tax code to ensure you’re not missing anything.
Lower your operating expenses
If you’re having trouble generating income, see where you can cut costs until your inflow picks back up again. Solutions could be as simple as working from home instead of paying for office space, to hiring an accountant who could help you lower your tax bill. Deploying energy-efficient utilities and lowering maintenance costs can also help reduce how much money is flowing out of your property every month.
Positive cash flow is one of the best indicators of how your rental property is performing financially. Make sure that more money is coming into your buildings than is going out on a consistent basis and you will be well on your way to maintaining financially viable rental properties. Remember, a “good” cash flow number is what you decide is good — just as long as that number is positive of course.
Real estate support and resources from AAOA
The American Apartment Owners Association (AAOA) understands the challenges you face as a property manager or landlord. That’s why we have made it our mission to make your job easier. We strive to provide you with the necessary tools to serve your tenants more effectively. We also believe that educated landlords make happier tenants, and in turn higher quality rental communities.
AAOA offers our members a vast amount of educational resources and services. These resources include our well-stocked live and on-demand webinar library that can help you maintain a positive rental property cash flow with sessions like, “How to protect your rental income” and “How to increase revenue in 2022.”
Additionally, AAOA offers a variety of services including our extensive and instant tenant screening, credit checks, more than 150 state-specific landlord forms, rental application, and relevant real estate updates that can be helpful whether you own a single rental unit or manage several of them. Meanwhile, our state-based vendor directory will give you access to countless approved vendors to help you handle apartment repairs, remodeling and more.
AAOA is here to help you oversee profitable rental properties, become a better landlord and more. Become a member today.