How To Get Cashflow From Your Investment Properties
Most beginner investors have studied enough books, seminars and other materials to have heard the term “Cashflow” at least once. But all too often they’re not clear what it includes… or doesn’t include.
At least once a week I get the question from someone “will this property cash flow?” What that tells me is that this person has not yet gotten sufficient training to answer that question for him or herself. If they had, they would know they never need to ask me that question – they must ask them self and their lender.
The truth is ANY property can cashflow. It depends almost entirely on the investor!
Here are a few preliminary questions I would ask in order to find out if a property would cash flow or not. (Observe: the questions are NOT about the property, but about the investor)
1. Have you been pre-qualified?
a. Yes
i. Have you chosen how much you’d like to put down on a property?
1. Yes - Great! (go to ii)
2. No - We will need to know that to assess if this property will potentially cash flow for you or not.
ii. Have you chosen what mortgage product you prefer for your price range?
1. Yes - Great! What will your monthly payment be?
2. No - We will need to know that to assess if this property will potentially cash flow for you or not.
b. No
i. Do you have a lender you prefer? Otherwise I can make some recommendations for you, so we know how much you can afford and when. Then we can estimate cash flow based on your monthly mortgage payment.
Once we have looked at these factors, we can see if the property is a match, based on market rental figures. And to be clear, we do always look for properties with the most potential for cash flow.
Now, let’s talk about what cash flow IS, and what cash flow ISN’T. Locate yourself in this conversation to decide how YOU area going to define cash flow when you are looking for your own properties. Here are some common measurements: (Observe: the broader the view, the more all-inclusive the perspective is.)
1. Monthly View: the difference between the monthly rent and the mortgage payment.
Pros/cons:
+This view is simple & straightforward, it is a “quick” measurement that is easily ascertained with only minimal information.
-It does not include many major benefits or many expenses and is overall, the least accurate method. (Not included: annual tax benefits, deductions, depreciation, and expenses such as: homeowners association, management, utility bills, travel expenses, postage, other maintenance/repair expenses.)
2. Annual View: at the end of a tax year, measures the difference between all mortgage expenses, association & management dues, utilities & repairs versus all rent received, interest and other deductions and depreciation taken.
Pros/cons:
+This view includes the bulk of factors involved without having too project far into the future. It is still user friendly, but includes enough information to be fairly accurate.
-It requires the investor to be more educated & have more information available or estimated. For the beginner, often looks like “too much work” versus monthly perspective. This figure still does not factor in some of the long-term expenses & benefits such as appreciation, tax-deferral and repair/replacement expenses.
3. Decadal View (means over a decade): includes everything in the Annual View plus figures the cost of replacement of major appliances, paint, carpet and any other foreseen improvements. Also includes appreciation and other long term benefits.
Pros/cons:
+It is the most “complete” analysis of true performance.
-It is the most difficult method to estimate projected costs and appreciation, as well as other unforeseen repair/replacement expenses.
Most likely to start out, you'll locate yourself somewhere in the middle (not one extreme or the other) in order to make the most educated choice. And your mentors can help you with details that you don’t know.
So, when you are seeking your properties that cash-flow, be clear how YOU want to define that - especially with your lender, who is your partner in making that happen! And if cash-flow is what you want, you can have it. Just keep in mind what choices you will have to make along the way in order to get it.
Now let’s discuss the portion of the Cash Flow subject that has nothing to do with the investor. Do some properties make it easer to Cash Flow than others? Absolutely! That’s where your agent/Realtor/mentor can help out considerably.
Consider that, for any property there is a ratio between the price of the property and the monthly rent it will command. When you think about it, it’s quite logical. But the higher that ratio, the easier it will be for you (or any investor) to make it cash flow, based on their personal choices.
But what do you REALLY want when it comes to real estate investing? (or any investing for that matter)
Wealth? - Comfort? - Status? - Security? - A Legacy?
Getting just the monthly cash flow from your rental-properties doesn't necessarily mean that your money is working as hard as it could be for you. And that's why you'll find that intermediate or experienced investors are focused very little on Cash Flow. They know that just because a property isn’t producing MONTHLY cash flow, doesn’t mean it can’t kick butt!
Here is a review of some of the factors that influence an investors ability to get optimal lending and optimal benefit from their investments:
· How much money are you putting down on your property? (sometimes a property that won't cash flow at 5% down, can be made to cash flow at 15% down, for example)
· What is your credit score? (the higher it is, the better interest rates - and, consequently mortgage products - you have access to.)
· How is your debt-to-income ratio? (and is it considered "good debt" or "bad debt"?)
· What tax-bracket are you in? (determined by your income - average is 35%)
· How much equity do you have? (include your home, IRAs, 401Ks, etc. - this measures some of your 'leverage')
· What type of mortgages do you like, or feel comfortable with?
If I try to estimate cash flow on a property, it's based on an average person - at an average credit score - with an average interest rate - in an average tax bracket - paying average taxes - average operating expenses - using the most common mortgage product(s) used by investors …. and then an estimated down payment (usually 10%).
Then people can see a fair estimate - or slightly lower-than-average cash flow scenario for themselves and customize it for their own scenario.
Your lender (if he/she is good) will have a far more detailed version based on YOUR numbers too. My numbers are basically "educated guesses" to help get people started before they talk to their lenders.
Author: Alex Anderson is a licensed RE/MAX Advantage-Plus agent in Minnesota. She specializes in helping people to build wealth and prepare for retirement with Minnesota Investment Property
