Cash Flow and Real Estate Investment Property
Cash flow is one of the major benefits real estate investors get by investing into rental income-producing property. In fact, cash flow (or income stream) is the primary reason real estate investors make investments in rental property.
Think about it. Whereas the decision to purchase a home might rest upon certain amenities and school zones, the physical property is a secondary issue to real estate investors. Investment property is about the numbers, and investors are really most interested in buying a property's cash flow (whether immediate or potential).
Fair enough. So given its importance, let's take a look at "cash flow."
What it Means
Simply put, cash flow is the rental property's revenue inflows less all its outflows. Namely, it's the money that remains after all the rents are collected and all the day-to-day expenses associated with owning the property are compensated.
Gross Scheduled Income
less Vacancy and Credit Loss
plus Other income
equals Gross Operating Income
less Operating Expenses
equals Net Operating Income
less Debt Service
equals Cash Flow
1. Cash flows are generally going to be collected in one of the following two ways (and both are crucial to the investor).
- Ongoing - this is the ongoing stream of income collected throughout the investor's holding period from rented units, coin-operated washers and dryers, storage facilities and so on.
- One-time - this is the one-time cashflow (or sales proceeds) real estate investors collect as a result of selling the investment property.
2. Cashflow is not categorically limited to any particular time frame. They may be daily, weekly, monthly, quarterly, semi-annually or annually. In our case, however, most real estate investors collect incomes monthly and most analysts evaluate a property's profitability on incomes collected annually.
3. Cashflows can be positive or negative. That is, a deficient amount of income (when outflows are greater than inflows) does not change the label, because both positive and negative incomes are considered "cash flow" regardless.
4. Cashflow is generally computed based on the investor's income tax ramifications. In other words, it can be considered as that income amount still subject to his or her tax payment, as well as that amount which still remains after said tax payment. It should be noted that this tax computation applies to both the ongoing income stream and the one-time amount collected resulting from a property sale.
- Cash Flow Before Taxes - the money collected but susceptible to annual Federal income taxes (also known as CFBT).
- Cash Flow After Taxes - the money the investor can really pocket once the IRS is satisfied (also known as CFAT).
Rule of Thumb
Some other things about rental property cash flows you should always consider before making your final investment decision.
- Always be realistic with all the income and expense numbers throughout your evaluation.
- It's always safer to anticipate a little or negative income you are able to handle with enough cash on hand rather than expecting to cover it by the property.
- Avoid cake-in-the-sky rents, overly-optimistic vacancy rates, and always include all the necessary operating expenses when you conduct your rental property analysis.
Here's to your real estate investing success.