Why become a real estate investor?
The answer to why you should become a real estate investor is simple ….. CASH FLOW!
There are many great reasons to invest in real estate, which we’ll discuss in a future post to come, but by far I invest for monthly cash flow.
What is cash flow?
In real estate terms, cash flow is the byproduct of owning a rental property and leasing it to tenants for a monthly rental income. Real estate investors look for rental properties with positive cash flow returns and invest in positive cash flow properties. If it does not cash flow, do not invest in that property.
Real estate investors want to receive extra income from renting their property after all expenses and costs have been taken out of the monthly rent paid by the tenant. Some of these expenses include mortgage payments, property taxes, insurance, sewer bill, etc. The rental income must cover your total expenses and have cash left over to consider a rental property profitable.
Cash flow is my number one goal and what determines if a property is worth me buying or not. Positive cash flow is needed to build and scale your business.
Cash flow should be your number one goal!
How to calculate monthly cash flow on a rental property?
Monthly rent collected minus:
- Monthly mortgage payment
- Property taxes
- Homeowners insurance
- HOA Fees (if applicable)
- Property Management (if applicable)
- Utilities (On single-family homes, I pay the sewer bill and my tenants pay all other utilities)
- Money set back for maintenance
- Money set back for vacancies
Equals cash flow!
Tips to help calculate cash flow
- Find a property you might be interested in purchasing using realtor.com, zillow.com, craigslist, or Facebook marketplace.
- If using a bank loan, contact the bank of your choice and ask out how many years they will loan to you on an investment property (usually 15 to 20 years), there down payment requirements (usually 20% to 30%), and the banks interest rates.
- Use an online mortgage calculator like the one found here at www.zillowhomeloans.com. I use the Mortgage by Zillow app on my phone, but there are many options available. Enter in all the information you’ve gathered about the property into the calculator, including the purchase price, to get you’re monthly mortgage payment amount.
- Use realtor.com or zillow.com to research the property taxes for the property. This is usually listed as the annual amount you will pay. Divide the annual property tax amount by 12 months to get your monthly payment amount.
- After you have your monthly mortgage and property tax payment amount, add them together with any other monthly expenses like the utilities, homeowners insurance, property management fees, HOA (Home Owners Association) fees, etc. This is your monthly expense number for that property.
- After you have your monthly expense number for the property, determine how much rent you can charge per the location of the home. For this, I use the Rentometer Express app on my phone. Simply enter the investment properties address, how many bedrooms at the property, and the rent you want to charge your tenants. The app will then calculate if the rent you’re planning to charge is fair for that location. It will also give you a fair rent range for the property. Using the app determine how much rent you will charge.
- The next step is to take the rent you decided to charge the tenant a month and subtract your total monthly expenses. If there is money left over after subtracting your expenses, that is your monthly positive cash flow.
If you’re a new investor just getting started, I do not recommend using a property manager. Property management companies normally take 15% of your rent amount on each home, which affects your cash flow. So if you charge $750 a month, you will pay a property manager $112.50 right off the top.
I recommend learning how to manage the properties on your own at first to save more money and to further use that money to continue investing. Once you reach more properties than you can or want to handle, then looking into a great local property management company might be a good option.
HOA (Homeowners Association)
I also do not recommend investing where there are HOA fees for the same reason. It’s money out of your pocket right from the top. They oftentimes, have restrictions on your home’s appearance, landscaping, who you can use for repairs, and whether or not you can rent out the home. On top of that, these restrictions can change at any time.
How much should you cash flow?
When it comes to how much money you should cash flow from a property, every investor is different. Some are happy to cash flow $50 after all expenses are paid and some won’t touch a property if it doesn’t cash flow at least $300 after all expenses. Some use what’s known as the 1% rule, which is based on the purchase price to determine if it’s worth investing. For me, I only invest in a property that will cash flow at least $200 or more a month. I have found this leaves me enough room to keep money back for unexpected repairs and vacancies. If the numbers work where I cash flow $200 plus a month, I’m willing to invest.
How the 1% rule works
The way the 1% rule works is simple: multiply the purchase price of the real estate asset (accounting for any necessary repairs that need to be completed) by one percent. The answer is then used to determine the base level of the monthly rent.
Real estate investors will then know how much they need to charge in rent every month to at least cover the cost of ownership. From there, investors may adjust their asking prices to increase profits (cash flow).
What should you do with your cash flow?
The answer to this question highly depends on your individual goals. Regardless of the answer I highly recommend you have all your properties bought under a business entity. Each business entity is different so contact a lawyer to figure out the best one for you and your goals. I’m not a financial adviser, CPA, or lawyer so please do your due diligence here and seek professional advice.
Once you set up your business entity, under the guidance of your professional adviser, lawyer, or CPA, open up a bank account under the business entity. Use that account to deposit all your monthly rent payments. You will now be able to pay all your monthly expenses with that account and keep whatever cash flow you have leftover. With that cash flow, you can either pay yourself to supplement your income from your W-2 job or save it to continue investing and growing your business.
In summary, cash flow is the key to making a good financial decision or a bad one. If you take your time and run all the numbers, cash flow from investing in real estate will help you supplement your income or boost your business into further growth. The more cash flow you create, the less chance you put yourself at risk. Do not get emotionally attached to a property. Let the numbers speak for themselves. If you can do that, you will accomplish your goals and understand how you reached them through the power of Cash Flow!