Hi Everyone,
It has been over 6 years since I purchased my first rental property. When I bought the first property, I had no idea what I should be looking for in a rental property. I thought that as long as the property increased in value, that was all the mattered.
Appreciation is a great thing to have when it come to real estate, however, it is not the most important thing.
You hear so many people talk about ‘cash flow’, and that a rental property needs to have a positive ‘cash flow’.
This is true, cash flow is important!
However, as a real estate investor, and a new one at that, you have to be very careful when it come to calculating cash flow.
Miscalculating Cash Flow
When you are purchasing a rental property, you have to be certain to not miscalculate the cash flow generated from the property. If you do this, you could end up purchasing a property with very limited cash flow, or even worse a property with a negative cash flow.
Be very careful, one error in your math could mean that you wind up owning a property that is costing you money each month, not earning you money!
Falsifying Cash Flow
Recently, and quite often I come across people who falsify cash flow on rental properties. I have seen a hand-full of realtors falsify the cash flow being generated on a rental property that they are trying to sell. These realtors are few and far between, however, there are some bad apples out there falsifying cash flow. They inflate the cash flow in order to make it seem that the property is generating a higher monthly positive cash flow.
I have also witnessed some real estate investors (landlords) falsify the cash flow generated on their rental properties. They do this for 2 reasons.
1) They want to impress other potential joint venture partners. They want to impress them that their subject rental property generates a high positive monthly cash flow.
2) They are trying to sell their property to a less experienced real estate investor, who will not take the necessary time to double check the cash flow calculations.
The Number One thing that you need to know when buying a rental property is:
You need to be concerned about the net income produced, not the ‘cash flow’
Net income refers to the money left over for you after all operational expenses have been subtracted. The net income is your true profit from the property.
Here is an example to help illustrate:
Mortgage payments —> $450/month
Insurance —-> $20/month
Property Tax —-> $200/month
Property management fee (optional) –> $115/month
condo fees —> $300/month
Repairs/Maintenance (5% of gross rent) –> $65/month
Vacancy (5% of gross rent) –> $65/month
In the following example, all of the above items are operational expenses, and should be subtracted from the monthly rent amount in order to get your net income.
If the monthly rent amount is $1300/month, your calculation would look as follows:
$1300 (rent) – $450 (mtg payment) – $20 (insurance) – $200 (property tax) – $115 (property tax) – $300 condo fees – $65 (repairs and maintenance) – $65 (vacancy) = $85/month net income
If one wanted to make the overall net income higher, one could falsify the ‘cash flow’ of this property by not counting certain items. If they did not count the $65 repairs and maintenance and $65 vacancy allowance, they could increase the over all cash flow to… $85/month net income + $65 (repairs and maintenance) + $65 (vacancy) = $215/month positive cash flow.
When you look at the two figures, which one looks better?
$85/month
or
$215/month
Clearly, $215/month looks better.
As a new real estate investor, you have to be very careful!
Often ‘cash flow’ projections of rental properties are falsified in this manner.
Be careful and always calculate for yourself what the true net income is being generated from a property.
The number one thing you need to know when buying a rental property is to ALWAYS calculate and KNOW what the NET INCOME is. Don’t be fooled!
Best Regards,
Neil Uttamsingh
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