I strongly agree that investors should buy rental properties for cash flow and not appreciation. I talk much more about why cash flow is so important in our podcast show “The Cash Flow Talk” on iTunes. Another question an investor must ask themselves is how much cash flow is needed on their rental properties? How much cash flow do you need to be secure? How much cash flow do you need to justify spending money on a rental property? How much cash flow do you need to reach your financial goals?
How do you calculate cash flow on a rental property?
The first step in figuring out how much cash flow you need is determining the actual cash flow on a rental property. The answer way to figure out is to deduct all the expenses the property has every month from the total amount the property is rented for.
It is very important that maintenance and vacancies are accounted for. I have learned that even on a completely remodeled home you will have maintenance issues with renters. Always plan for the worst, but hope for the best.
Positive cash flow is very important with rental properties
After you figure out your exact monthly cash flow, you may realize the numbers don’t look as good as you first thought. If you are using a property manager, they can really cut into your returns, but many times are well worth the cost. You have to remember just because the rent coming in is slightly more than the mortgage, that does not mean you are making money.
It is very disappointing to be paying money into a property every month that is supposed to be making you a profit. It is true that you are paying down the mortgage and getting tax benefits from the rental property, but negative cash flow can cause a lot of stress even with those benefits. If you are hoping for appreciation, remember there is no guarantee that prices will increase. How long are you willing to pay into a rental property before it pays you back? The easy solution to this problem is to make sure any rental property you purchase has positive cash flow!
Why should you be conservative with your cash flow estimates?
I like to plan for the worst, but hope for the best. I designed the cash flow calculator to be conservative and account for maintenance and vacancies. My actual returns have been better than what the cash flow calculator estimates, but I have been lucky with vacancies and repairs. The does not mean I will always be lucky and one really bad tenant or big repair can make up for years of smooth sailing.
If your vacancies or maintenance ends up being higher than you think, it is best that you planned for the worst case scenario. Hopefully with unexpected costs you will still have positive cash flow if you were conservative in your planning. I have $500 a month in cash flow on my rental properties and that is plenty of room to absorb unexpected costs.