Calculating cash flow is an essential part of owning a rental property - in fact, this calculation should ideally be made before purchasing the property to ensure it’s a viable investment. Cash flow relates to the amount of money coming into and out of a business. So, in terms of a rental property, this refers to received rent and fees set against maintenance fees, taxes, and other expenses.
How to Calculate the Cash Flow on a Rental Property
The cash flow rental property calculation is different from calculations regarding the rent ledger or working out your capital gains figure for tax purposes. It’s a relatively quick and easy one to make. It should include the gross rental income and any additional rental income you expect to receive on the property as incomings.
On the expenses side, things should be included, such as mortgage and insurance costs, maintenance and repairs expenses, property tax, capital expenditure reserve contributions, property management charges, leasing fees, and other service expenses like landscaping and cleaning costs.
After subtracting the expenses from the income, the remaining amount is the average cash flow on a rental property. A typical cash flow calculation could look like this:
|Gross Rental Income||$1050|
|- Mortgage payment||-$280|
|- Property taxes||-$210|
|- Maintenance costs||-$75|
|- Property management fees||-$80|
|- Capital expenditure reserve||-$90|
|Average Cash Flow||$205|
What is a Good Cash Flow on a Rental Property?
In general, a good average cash flow on a rental property is one that generates a positive net income after all expenses have been deducted. A common benchmark used by real estate investors is to aim for a cash flow of at least 10% of the property's purchase price per year. For example, if a property is purchased for $200,000, the annual cash flow should be at least $20,000 ($1,667 per month). Many landlords also use either the 2% or 50% rule to determine what is and isn’t a good average cash flow.
The 50% Rule
This rule is quite simple and can be used if you just need a very quick estimate of an average cash flow: you divide the gross rental income by two and subtract the mortgage payment. In the example above, this would be:
$1050/2 - $280 = $245
The 2% Rule
According to this rule, if the rental property can generate an income equal to or above 2% of the property’s purchase price, this is considered a good average cash flow. Sticking with our example above, and supposing that the purchase price was $60,000. The calculation would be as follows:
$60,000 x 2% = $1,200
This property, therefore, does not pass the 2% rule. However, it is worth noting that such ‘2%’ properties are rare: they are most likely to be found in the midwest or rural areas, or even as far as south of the U.S real estate market. If you're investing in Los Angeles or New York, the 2% rule is quite an unrealistic benchmark.
Ways to boost your property's cash flow
One of the most obvious ways to increase cash flow is to raise the rent on the property. While it's always important to check the rent you’re charging against average rental prices in your area to make sure that your fees are in line with the market, raising the rent is not the only way to increase your net income on the property.
Save on Insurance
There can be a surprisingly significant difference in the premiums you’ll be charged by different companies for landlord insurance. An easy way to boost your property’s cash flow is to spend some time looking at the options available to get the most competitive price for an insurance package that provides all the cover you need - a saving of just $25 a month would equal $300 yearly. Honeycomb specializes in rental property insurance - check how much you can save on your insurance here.
Get Plenty of Quotes for Property Management Services
As with insurance, it can serve you very well to get as many quotes as possible from different companies for property management services. Given that the average charge for property management services is between 7% and 10% of the monthly rent, this could equal a difference of up to $342 regarding your yearly average cash flow.
Reduce Maintenance Costs
While it’s vital to keep providing maintenance services to your tenants as detailed in the rental agreements, there may be ways to save on this, too. For example, could you undertake some of the simpler tasks, such as lawn cutting, yourself to increase your property’s cash flow? You could also try negotiating with the maintenance services company you currently use - would they be able to offer you a 10% discount, for example, if you made an annual, rather than monthly, payment?
If, as the landlord, you’re responsible for paying the utilities, it’s worth considering replacing old or inefficient appliances within the property to reduce this expense. A furnace, for example, could be switched out for a heat pump, while newer, efficient shower heads and toilets are available that can significantly reduce water/energy costs. Installing eco-friendly solutions can also boost the property value.
Appeal Your Property’s Taxes
If similar properties in your area have recently sold for significantly less than the value put on the property that determines its rate of tax, you may be able to lodge an appeal. If successful, this could substantially lower the property tax you’ll be liable for. However, it’s vital to bear in mind that a reconsideration could go either way - therefore, meaning there’s a chance your property’s tax rate could actually increase, so proceed with caution!
Keep vacancies at a minimum
Reducing your property’s vacancy rate is another important factor in keeping your cash flow positive. To this end, ensure you have a thorough process of screening for prospective tenants (this helps decrease the likelihood of getting stuck with problem tenants) and think about introducing a longer minimum rental period.
Compare your rental price to the rest of the market
It’s also important to check the rent you’re charging against average rental prices in your area annually to make sure that your fees are in line with the market. And if you don’t currently charge pet fees, this is something you could think about introducing to increase your property’s cash flow further.
The Bottom Line
Calculating your rental property’s cash flow is an important factor in determining the average income from your rental property and ensuring your property is both profitable and continues to be so. Checking that a property you’re considering purchasing is a viable investment by undertaking this simple calculation means you can see, at a glance, the income you can expect it to generate.
Cash flow on a rental property should be viewed as a dynamic element of your business: check this calculation regularly to see where savings could be made or charges increased to keep your rental business’s bottom line as healthy as possible.