Are you looking to invest in rental property, but don’t know how to make sure that it’s profitable? We understand. Investing in a new rental home can be a risk, and it can be hard to predict exactly which properties will be worth it and which ones will result in lost money. That’s where cash flow comes in!
Learn about business cash flow, how to define cash flow and calculate it, and things that can benefit your cash flow as a rental property owner.
What Does Cash Flow Mean?
When you’re beginning to consider investing in a rental property, there are two main financial components that you need to be able to predict and take into account. These are your expenses and your income.
Your cash flow will be any money that you bring in from the rental property after you have subtracted any expenses associated with the home, such as your mortgage, in addition to putting some funds away in case you need to cover a necessary repair.
Anything left over is your cash flow, and your goal should be to make this number as high as you can in order to make sure that your rental property remains profitable for you.
Why Is It Important to Maintain a Positive Cash Flow?
Aside from the fact that making a profit on your rental property is what most real estate investors are aiming for, there are many reasons why having a positive cash flow is important.
First, cash flow can bring you more opportunities in the long run. Taking your profits from a rental property and reinvesting them can help you to grow your financial health and maybe even expand your rental property portfolio.
Second, cash flow can provide you with a safety net that you may have otherwise not had. A positive cash flow can help you to prepare for unexpected life expenses, including anything related to your rental property.
How Is Cash Flow Calculated?
In order to calculate the amount of cash flow you will generate from your rental property, we’ll need to start with a simple equation:
Gross rental income – all expenses and cash reserves = your cash flow
If you’re needing a quick and easy cash flow estimate for a rental property that you are considering investing in, using an online ROI calculator can be extremely useful.
Things That Can Hurt Your Cash Flow
1. Maintenance and Repairs for Your Rental Property
Many rental property owners cite maintenance and repairs as being one of the most difficult aspects of operating a rental home. This is because maintenance on a rental home can be costly, time-consuming, and an overall frustrating chore to deal with.
After all, no one wants to find out that their property needs a new furnace, or that the roof has been leaking. However, these things can and will happen over time, and it is important to plan for them financially and strategically.
As a rental property owner, you should be saving a portion of your income each month in order to account for maintenance and repairs that may need to happen to your property. This will give you a healthy safety net that you can use to lower the inconvenience of these unexpected costs.
However, sometimes the costs that come with maintenance and repairs can tend to exceed the amount of money that you have saved up in preparation. If this occurs, you may experience an unfortunate dip in your cash flow.
2. High Tenant Turnover
Having a high vacancy rate is definitely bad for business. When you frequently need to search for new tenants, you will have to spend more money on marketing, tenant screening, repairs, and cleaning than you would if you had long-term tenants occupying your rental home.
3. Missed Rent Payments
Every once in a while you may end up with a tenant who fails to pay their rent on time, or at all. As you may expect, your cash flow will take a huge hit if this happens. As a landlord, your primary source of income when it comes to your rental properties relies on your tenants paying rent on time, each and every month.
On top of that, failing to receive your monthly rent payment means that you will have to pay for all of your property’s expenses out of pocket.
4. Rental Property Vacancies
If your rental property is sitting vacant, that means that it is quite literally failing to generate any income for you as the owner of the home. Without any income, you will not have any cash flow, and since you own the property, you will need to cover all the associated costs out of pocket.
This includes things like mortgage payments, maintenance and repair costs, taxes, and more. Being stuck with a vacant rental property is definitely not a situation that any landlord wants to be in!
5. Property Tax and Insurance Payments
Sometimes your property taxes and insurance costs can increase over time, causing your cash flow to take a hit. While you may be caught off guard at first, it’s important to note that it is very common for these prices to increase over time, and you must be able to prepare for these increases or find a better deal elsewhere!
Cash Flow Management: How to Increase Your Cash Flow
1. Increasing the Cost of Rent
The most obvious and the most common way to increase your cash flow is to increase the cost of the rent on your property. However, it is not always as simple as it sounds.
In order to increase the rent, you often need to also increase the desirability of your rental property. This can be anything from remodeling the kitchen to adding a central AC unit. Making the home more appealing to tenants will make them more inclined to spend the extra money on their monthly rent.
2. Maintaining Long-Term Tenants
As mentioned above, high tenant turnover and rental property vacancy can have big effects on your cash flow, and not in a positive way! The best way to avoid this is to put effort into maintaining long-term tenants who are qualified and reliable.
How exactly do you do that? The answer is simple: keep them happy in your rental property. This includes responding to and fixing maintenance issues right away, and avoiding raising rent costs when you don’t have to.
3. Regular Preventative Maintenance
Large repairs and maintenance projects can hurt your cash flow, especially when they come up unexpectedly. However, by ensuring that you are frequently conducting preventative maintenance on your property, you can diminish these risks.
Preventative maintenance can include things like regular inspections and making small, frequent repairs. Doing this will help you to avoid those larger, more costly problems in the future, protecting your cash flow.
4. Appeal Your Property Taxes
Similar to your insurance, the cost of your property taxes can go up annually. If they happen to go up at a faster rate than you are able to keep up with by reasonably raising the cost of your rent, your cash flow may end up suffering.
However, depending on which market your rental property is in, you may be able to appeal the tax increase to your local government.
5. Refinancing Your Property
As a landlord, it can be a good idea to check in with your mortgage lender and keep a close eye on your rates. If you notice that the mortgage rates are falling, you could potentially refinance, which may result in a lower monthly mortgage payment. This would increase your cash flow, as your expenses would go down each month.
The 1% Rule and How It Can Help You Invest Wisely
One of the most effective ways to quickly and easily figure out whether or not a rental property will generate a positive cash flow is by using the 1% rule.
Essentially, this rule states that if a rental property is able to generate a monthly rent of at least 1% of the amount you purchased it for, it will most likely provide a healthy cash flow in the long run.
For example, let’s say you purchase a rental home for $100,000. If you are able to rent out the home for at least $1,000 each month, then the property would pass the 1% rule.
Now, just because a rental property is able to pass this rule does not automatically mean that it will be a sound investment for you. Make sure to keep in mind the wide range of expenses that often come along with owning a rental property, including HOA fees, mortgage rates, property taxes, marketing costs, repairs, and more.
Cash Flow Meaning: Bottom Line
The bottom line is, a healthy cash flow is the exact thing that makes all the hard work of owning and operating a rental property worth it. By using the tips and tricks listed above, we’re confident that you’ll be able to increase your income, lower your expenses, and optimize your investment in no time.