This is the second part of a four part series which details the steps in the original article published in the 2/28/13 edition of the Showcase titled Becoming a successful investment property owner.
To refresh your memory, step two said, “…calculate income and expenses to get an idea of the cash flow.”
More frequently, this step is performed before an investment property is purchased. An investor will research the property and obtain the necessary figures from the seller to calculate the cash flow. Determining if a property will cash flow is critical in making an investment decision.
However, this process can also be utilized by owners/investors that already own investment properties. Maybe the property was inherited, or perhaps you are buying a second property to call home and plan on renting your current residence. Whatever the case may be, calculating the cash flow is necessary to becoming a successful owner of that investment property.
First, start with income. This will include the monthly rent the property generates as well as any other income the property produces from parking fees, on-site laundry, additional storage fees, etc. After arriving at an annual income total, or GRI (Gross Rental Income), factor in the vacancy rate. If you are unsure of what vacancy rate to apply, plug in a number from four to five percent, which is the current trend according to the National Association of Realtors. After multiplying the vacancy rate with GRI, you’ll arrive at EGI (Effective Gross Income).
Next, calculate the expenses. An easy acronym to remember expenses is “TIMMUR”, according to the California Association of Realtors. This includes taxes (property), insurance, maintenance, management fees, utilities, and reserves for replacements. Convert any monthly figures into an annual total. Subtracting the total yearly expenses from EGI will give you the NOI (Net Operating Income).
Finally, you will need to subtract any mortgage debt(s) on the property from the NOI. The final figure will give you the cash flow before taxes.
Having a negative cash flow means you will have to come up with additional money to cover the operating expenses and/or mortgage debt payments.
On the other hand, if the results show a positive cash flow, then your rental property is generating a source of passive income. This passive income is producing cash on a predictable and consistent basis and is relatively easy to maintain.
To make these calculations easier for you, Barrett Property Management has provided a free downloadable Cash Flow Worksheet, which is available at: http://barrettpm.com/downloads/