For investors looking to broaden their portfolios, turning towards real estate investing can be a great source of passive income. It seems easy enough to buy a rental property, find high-quality tenants, and then sit back and collect rental payments on a monthly basis.
But as with any long term investment, the key to maintaining a smart investment strategy with a high ROI is to understand cash flow, do your research and learn how to optimize your investment to generate positive returns.
What is Cash Flow?
In terms of real estate investments, cash flow is the profit left over from the total income generated from your property after all expenses have been deducted. The income for a rental property is the monthly rent paid to the landlord, while the expenses can include everything from taxes and insurance payments to sudden repairs and maintenance.
The aim is to generate positive cash flow rather than zero or negative, where the expenses are greater than the income with additional cash reserves for unexpected costs.
For real estate investors, keeping close tabs on the financial statements and breakdown of costs relating to the property is vital in understanding where the money comes in and where it goes, in order to make accurate cash flow projections.
Doing a Cash Flow Analysis of Your Investment!
To understand how to increase the cash flow from investing activities, investors need to analyse their business operations to help identify potential methods of increasing income.
While determining the total income from your rental property is straightforward enough, calculating the expenses can be tricky, with plenty of hidden costs that can be easily overlooked by first-time investors.
How to Calculate Cash Flow?
The basic equation for calculating the profit or cash flow from your property is simple:
Gross income – Gross expenses = Cash flow
Breaking these figures down is the hard part. For a rental property, the total income is generally limited to the accounts receivable in the form of monthly rental payments made to the property owner.
The expenses, however, are numerous and sometimes unpredictable. While some are billed on a monthly basis, one-time expenses and sudden costs are also a part of the risks of investing in long term assets like property. Some of these expenses may include:
- Utility payments
- Repairs and maintenance (including materials, trades person fees, etc.)
- Property taxes
- Insurance payments
- Homeowner association fees
- Property management fees
- Advertising costs (when leasing the property)
- Legal and professional fees
By doing research and consulting industry experts like real estate agents and investment finance specialists, property investors can solve their cash flow problem areas through careful planning and management.
What Causes Negative Cash Flow for Your Rental Property?
Even if you’ve budgeted carefully and set aside enough money for a few repairs, there’s no predicting what can go wrong. Everything from a jammed door or broken toilet to extensive property damage from adverse weather or accidents can not only deplete your savings but severely impact your cash flow statement in the long run.
High Tenant Turnover
Not only will the days vacant affect your rental income, a high number of tenants moving out may incur additional cleaning or maintenance costs that will add up.
Missed Rental Payments
By leasing your property out to tenants, you run the risk of losing out on rental income if and when they are unable to make payments. Whether this is the full rental amount owed or additional costs like utilities or maintenance, this is a serious blow to your income.
If a few arrears can affect your cash flow, then a completely vacant property will halt your rental income entirely. Keep your rental property’s vacancy to an absolute minimum to reduce the financial damage.
While it’s hard to predict what costs can crop up, good financial management and careful consideration of your balance sheet can help identify expenses that can be reduced, such as choosing less expensive tradespeople for repairs.
What Influences Positive Cash Flow for Your Rental Property?
1. Increasing Rental Amount
While increasing the rent is the easiest way for real estate investors to boost their cash flow, ensuring a steady rental income must be a balance between charging just enough to cover expenses and charging too much, which will limit your pool of prospective tenants and risk a high vacancy rate.
2. Securing Long Term Tenants
If you’re lucky enough to secure high quality tenants that pay their rent on time, it is in your best interest to keep them happy. With long term tenants, you eliminate turnover and vacancy, which are major factors in reducing your rental income.
3. Investing in Home Improvements and Renovations
Additional features and selling points will drive the value of your property up and justify increases in rental amounts, whether it’s a big addition like a home office or pool, or simply upgrading existing features and doing preventative maintenance.
4. Proactive Property Management
Keeping a close eye on your property will save you money in the long run. Timely responses to maintenance requests, routine inspections to make sure the property is in top condition and staying on top of property management tasks will ensure both long terms tenants and fewer big or unexpected expenses, resulting in positive cash flow.
5. Claiming Tax-Deductible Expenses
Depending on local tax laws certain expenses may be tax deductible, which could greatly increase your positive returns. It is worth consulting your accountant to find out what you qualify for, from property management fees to home equity lines of credit.
Cash Flow Management
Real estate investing requires a thorough analysis of the real estate market, which is key to understanding the value of your investment properties and how much income you can potentially earn.
Cash flow projections are similarly heavily influenced by market trends, and real estate investors need to know key factors like local rental, growth and vacancy rates to accurately predict the cash flow projections for their investment. Investing in expert assistance will provide multiple benefits in the long run, including maximizing your cash flow and ensuring the highest possible ROI.