Looking for ways to calculate cash flow for a rental property.
This blog is meant for you only. As it will work out as a guide to calculate the cash flow for a rental property and will further make sure it’s also profitable.
This approach is what we look for any time we invest in real estate and by the way, this is probably the most important step anytime you’re looking at investing in real estate.
It’s this one simple calculation that tells you everything you need to know about the property.
CALCULATE the GROSS
The first step you need to do anytime you’re calculating the cash flow of a rental property is to calculate what’s called the gross income.
Gross can be defined as the total income of a property before any expenses.
Now when you have gross income there are typically two types of gross income anytime you’re going to be looking at a property online.
A. TYPES of GROSS INCOME
The first is what’s called the actual income, the second is what’s called projected income.
Actual income is just how much the property is currently making right now with actual rents.
Typically when you see actual income this just means that the building is currently being rented out and this is the actual amount of rent that the owner is receiving from all of the units.
Then we have the second type, known as the projected income.
This is something you’re probably going to be seeing all the time if you’re looking at properties online.
It is the projected amount of rent they think they can get if the unit becomes vacant and you rent it at current market rates.
They pretty much tell you the estimated rent of the concerned unit.
If your current tenant moves out and you go and get a brand new tenant in there this is how much that unit will be worth.
Now when it comes to us, we just ignore the projected income and unit’s worth.
You may like to know the reason for this.
Well, we do it because we need to do our calculations to determine what the unit can rent for and not listen to the owner.
Because most of the time the owners’ projected income is very optimistic and more generous than the unit is worth.
So our advice would be to not take them on their word.
To give you more insights we would like to propose an example.
Let’s say we have a building selling for $360,000 with three units and each unit is being rented for $1000.
This means that the gross rents that the building is getting are $3000/month or $36,000 per year.
Now in addition to the rents, it’s also very important to identify any other income sources that the property might be generated as some properties might have different types of income, like laundry income, storage income, or parking income.
So in such cases just add any of the additional income on top of what the property is receiving in rent.
For this example let’s assume, the owner is not gouging the tenants for additional services and all of it is included in the rent.
So, we have the gross income.
Moving on to the next step, which is ‘EXPENSES’.
WHAT is FIXED EXPENSES!
While buying a property you’re going to have what’s called fixed expenses.
These expenses will have to be borne no matter what. If you bought the property in cash and it doesn’t have a mortgage still you’re going to have these expenses as it includes property tax and there’s no way around it.
Then we have insurance followed by the cost of a homeowner’s association (HOA), then the utility charges if you’re responsible for paying some of those for the tenant.
In which case, you’ll probably also have normal upkeep like a gardener, maybe some pest control or anything else like this, then you’ll also have the inevitable repairs that will eventually need to be done at some point.
You’ll also have management fees if you decide to get a property manager and then finally you’re gonna be having some vacancy which is when a tenant moves out the unit’s not being rented and you’re losing out on some income so now let’s fill in some of these examples for our building.
Let’s say the property taxes are going to be $360/month along with the insurance which will be another $150/month.
Let’s assume, there’s an HOA and it’s $50/month we’ll assume that the tenants pay all of the
utilities so that is $0 a month and you also have to pay $50/month for the gardener.
Then let’s say the repairs are about $100/month with an additional $200/month in property management.
Finally, we’ll throw in the additional $100/month for the average vacancy just as an example that brings our total fixed expenses to $1010/month.
This means that even if you own the property outright even with cash without any mortgage you’re still gonna have the fixed $1010/month in expenses.
CALCULATING NET RENTAL INCOME
Now it’s time to figure out what our net rental income is going to be.
The net rental income is calculated by taking the gross income and subtracting our fixed expenses and there we have our net rental income.
So in this example, we take our $3000/month gross rent minus $1010/month in fixed expenses which brings us to $1990/month in net rental income.
If you ended up buying this property with cash-out rights, you don’t have any sort of mortgage, well there you have your cash flow.
You paid $360,000 for a property that makes $23,880/year, which means you’re getting a 6.63% return on your money.
You may want to know, how did we calculate all of this, right?
All you need to do is divide the net rental income by the price you paid for the property and then multiply that number by a hundred and then what you have left over is your percentage return.
Also known as the ‘cap rate of property’ it doesn’t stop there because if you’re a smart real estate investor you know, it’s better to get a mortgage and leverage your money to get an even higher return.
So, let us explain how you can get this property to pay you more than a 10% total return on your money just by getting a mortgage.
Let’s have another example assuming, you’re putting 20% as a down payment on the property and then you’re financing the rest and a 5% interest rate over 30 years.
CALCULATING the MORTGAGE
Now, to calculate the mortgage you could refer to any website online where you just plugged in all the numbers and it gives you the final results.
Let’s try to do it here, first of all, we got a $360,000 home value. We’ll put a 20% down payment and assume the interest rate is 5% for a 30-year loan.
On calculating it gives us a total payment of $1546/month.
Now, what we will do is, take our net rental income after all the expenses of $1990 and subtract out mortgage payments of $1546one thousand five, and that gives us a leftover of $444 every single month.
After making the mortgage payment now here’s how we calculate your return. Remember you put $72,000 as a down payment to buy this property.
Well the thing is anytime you buy a property it’s never just the down payment when you buy it there are always closing costs associated with that property.
In this scenario let’s assume that the closing costs on the property are going to be equal to 1% of the purchase price and that would be $3,600 as our closing costs.
This means your total investment at the property is $72,000 in down payment plus your $3,600 in closing costs which brings the total investment to $75,600.
It means you have invested $75,600 to make a monthly net return of $444/month and that also works out to be $5328 per year.
Now we just repeat the same calculation that was done before and take our net rental income of $5328.
We divide that by our total investment to buy the property which costs $75,600 and multiply the number by 100 which will give you a total return of just over 7% on your money.
If you are thinking it’s the end, we would like to hold your horses there.
The 7% is just your cash return.
There is also the return on the equity portion of this entire calculation because remember that every single month that you pay your mortgage part of that payment is the interest that you owe on the balance of your loan.
The other part is the equity, the amount of principal you are paying down every single month so every month that goes by that you’re paying a mortgage is a month closer to you own 100% of that property.
So to calculate how much equity you’re paying down let’s go back to our initial mortgage calculations, once you input all of your numbers you’re further going to calculate the annual amortization.
Then, you could see that in the first year you pay down your total loan balance by $4249, and remember this is straight-up equity in the property. So, we count this as income as part of your total return.
So now we take the $4249 in equity of the first year by paying down the mortgage and add in the $5328 cash return that you get from your rents again after all the expenses and paying the mortgage that brings the total ROI on this property to $9570 in the first year.
And, then of course, if we do the normal calculation by taking that number and dividing it by $75,600 multiplied by $100, again that gives us a 12.6% return for the first year.
It’s a very steady, predictable, and guaranteed 12.6% return.
This is why we love dealing in real estate and with this entire formula, you can also fall in love with it.
Plugging in your numbers is going to give you the expected return of the property and also use this calculation to determine how much a property is worth.
SUMMING UP!
By following this real estate investment guide to calculating the cash flow you can compare
the expected return of one property against everything else that’s selling on the market.
And then based on that you can tell whether or not it’s priced in line with everything else or if it’s overpriced or underpriced.
We also recommend these calculations to determine how much we are going to be making from these investments especially when you begin renovating properties, raising rents, and adding value to the properties.
This is where these rent numbers take off and if you’re ever thinking about getting in and investing in real estate this is the most important thing that you will need to get yourself acquainted with.
We believe this blog will help you in going forward on your journey of real estate investment and will further aid in making tons of money in the future.