To make money with investment properties, you have two options: you can collect rents from the people who chose to live in them, and the property can increase its value over time, thanks to appreciation.
While the appreciation of your property is certainly nice, it is widely agreed that cash flow is the more important thing to consider when acquiring investment properties like multifamily real estate.
For one thing, cash flow is predictable in these types of properties, while long-term price appreciation is not. Also, positive cash flow allows all of the property’s expenses to get paid without money coming out of your pocket. In other words, when managed properly, it effectively pays for itself.
With that in mind, here’s a quick guide to estimating the cash flow of potential rental properties to help you narrow down your search.
Cash flow is the name of the game
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The most simple definition of cash flow is income minus expenses. If an asset rental income is greater than the costs of owning, operating, and managing the property, it will yield positive cash flow. Conversely, if a property costs you more than the income it produces, it would have negative cash flow.
The most basic test you can perform when scouting for investment properties is to determine if the property will produce positive cash flow or not. After performing conservative estimates, you can decide if you want to go further or not by the income it will produce compared to the amount of money you’ll be investing.
Seasoned investors can determine whether a property will net positive cash flow by just looking at its listing, and this is how.
With that in mind, let’s go over how to quickly — and conservatively — estimate the cash flow of potential investment properties.
How to tell if a property will generate positive cash flow
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It would be fantastic if you could collect rent from your tenant(s) each month, pay your mortgage, insurance, and property taxes, and just pocket the difference as your profit. Unfortunately, it doesn’t usually work out this way — especially on a long-term basis.
At some point, your property is going to need some maintenance or repairs. And at some point, your property will likely be vacant as you search for new tenants. There’s no set-in-stone rule when it comes to projecting these setbacks. By nature, they are rather unpredictable, but there’s an approach you can take.
When it comes to maintenance, it depends on the age and condition of the property. Assuming that you’re going to spend a fair amount of money initially taking care of whatever immediate repair and maintenance work, consider ongoing maintenance to be in a range from 5% to 15% of the rent.
The lower end of the range is what you should use if the property is new or in outstanding condition, while the higher end should be considered if a property is old or in less than optimal condition. Finally, when it comes to maintenance consider the middle range (about 10% or so) for the majority of properties you’ll come across during your research.
To account for vacancy expenses, consider a similar strategy. Generally speaking, assume that all of your properties will be vacant for one month each year, and to be safe, round it up to 10% of the time.
If you don’t end up spending the money on maintenance and the property is always fully occupied, great. However, you want to plan for a real-world situation, so it’s best to err on the side of caution.
Finally, it’s important to budget for property management unless you plan on doing that yourself. If you already have a property manager, you can use their actual rates, but the industry standard for long-term rental properties is 10% of the collected rent.
How to calculate cash flow
Let’s say a property you’re considering has a price tag of $110,000. Including taxes and insurance, and assuming 20% down, you can reasonably expect to pay about $750 per month or so. Assuming the property’s current rent is $1,100 per month, your cash flow calculation could look like this:
| Item | Amount |
| Rental income | $1,100 |
| Mortgage payment (PITI) | $750 |
| Property management | $110 |
| Vacancy allowance | $110 |
| Maintenance reserves | $110 |
| Total expenses | $1,080 |
| Cash flow | +$20 |
This property passes the most basic test of positive initial cash flow. Sure, $20 per month might not sound like much, and more would be better, but this is based on generous reserves for vacancies and maintenance.
And keep in mind that this is initial cash flow — rental income tends to rise over time. The point of this cash flow calculation is to show that after all reasonable expenses, I can expect this property to add to my bank account every month and not be a money drain from day one. (Tip: Multifamily properties tend to cash flow better than single-family homes like this one.)
Always be realistic with your estimations
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As a final word of caution, it’s important to realize that your cash flow estimates are only good if you’re realistic about your assumptions when it comes to income and expenses.
For the rental income, this is easier if the property you’re considering is already occupied. For example, if you’re looking at a triplex that’s fully rented and bringing in $3,000 per month, it’s safe to use that figure in your cash flow estimates. On the other hand, if the property is vacant, it’s important to be realistic about what the property could rent for.
On a similar note, be realistic with your expense assumptions when it comes to vacancies, maintenance, and financing. Take the time to get a quote from a lender, as you may be surprised by how much more expensive rental property financing can be.
Also, be realistic about how much you think you could get the property for — if a rental property is listed for $200,000, it may be a bit too optimistic to simply assume you can buy it for $150,000 when determining cash flow potential.
The bottom line is that you want to know if your property will cash flow in reality, not just under the circumstances where everything works out perfectly.