Cash flow is the most important factor when buying long-term rental properties. I own ten long-term rental properties and my goal on each property is to have great cash flow. However, rental properties with the biggest margin between the rent and mortgage payment will not always have the highest cash flow. There are many factors you have to consider when figuring cash flow; expenses, turnover, vacancies, management and more.
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What is cash flow on rental properties?
When you buy a rental property, you want to make money every month from the rent coming in. I know some investors buy for appreciation, but here I explain why investing for appreciation is a bad idea. Cash flow is the amount of money you make each month on a rental property after expenses. You have to figure all your expenses including taxes, insurance, mortgage payments, repairs, maintenance, HOA, property management, vacancies and any other costs you may have. I have a great tool to figure cash flow; the free cash flow calculator.
Some of these costs may not occur every month, but you still have to account for them. You will have vacancies and repairs on every house at some point. You may not have any repairs for two years on a home, but have to spend $5,000 on a new roof in the third year. Make sure you account for repairs and vacancies when figuring cash flow.
How do you figure cash flow on rental properties?
It is pretty simple to figure cash flow once you know all of your costs. To figure cash flow, subtract all of your monthly expenses from your rent payment and you are left with your cash flow. Some people like to use the 50% rule to figure expenses, but I feel it is better to list out all of your expenses and not use a rule that does not account for local variances. The 50% rule states that your expenses not including your mortgage payments will be 50% of the rent received.
What is the 50% rule when calculating expenses on rental property?
The 50% rule states the total expenses (not including mortgage payments) for a rental property will be 50% of the monthly rent. If your rent is $1,400 a month, then the 50% rule says your expenses will be $700 a month. I don’t like the 50% rule because it does not account for tax rates, type of property or many other variables that change from property to property. I think cash flow should be figured on each property considering each expense. For example, the tax rate in my area is about .05% of the value of a home, but in other areas of the country the tax rates are five times higher. The 50% rule does not account for differences like this or any other differences in expenses.
How to increase cash flow by choosing the right rental property in your market
In my market, single family homes cash flow better than multifamily homes. This is not the case in every market and in many markets multifamily homes cash flow better than single family homes. You have to do your research and figure out the best type of property in your market. Here is a more detailed explanation on why I choose single family homes.
I also research what the price to rent ratio is in certain neighborhoods in my area. I choose locations that have a high rent to purchase price ratios, because they make the most money. I also choose homes that will attract stable tenants and are easy to rent. There is a balance I try to find between a great price to rent ratio and a stable property which I will discuss shortly.
How to increase cash flow by buying rental properties below market value
The better deal you can get on an investment property, the more cash flow you are going to have. Buying homes below market value is the best way to get great cash flow and gain instant equity. I buy my properties at least 15% below market value and that is a key to my investing strategy. It takes time and hard work to get great deals and I explain how I do it in my book; How to Buy Real Estate Below Market Value, which is available as an 116 page E book on Amazon or as a PDF here.
Why newer homes can increase cash flow on rental properties
Sometimes the houses that seem to have the best cash flow are the cheapest homes in an area. These houses may not always end up with the most cash flow after you account for repairs and turnover. In my area the cheapest homes are the oldest homes and houses that are 100 years old are going to need more maintenance than newer homes. The newer a home is, the less you are going to spend on repairs and the more cash flow you will have.
Stable tenants can increase cash flow on rental properties
I love single family homes because they promote stable tenants. Tenants tend to think of houses as their own home and take care of them better than an apartment. Tenants may also stay in a single family home longer than an apartment. The less turnover and vacancies you have, the more cash flow you will have. In many markets, the more expensive a home is the longer the tenants tend to stay, but rent to price ratios also tend to go down the more expensive a home is. This is another instance where a balance must be found between stable tenants and price to rent ratios. If you have to rent a property every year or sooner and you have a month vacant every year, your cash flow will suffer greatly. Here is an article explaining exactly how to keep a home rented.
How to increase cash flow by managing your own rental properties
It is possible to manage your own rental properties if you have the time and are close to your properties. Managing rental properties is not for everyone, you have to stay on your tenants and do your due diligence when choosing tenants.
Property managers typically charge 8 to 12 percent of the monthly rents. That can add up to a lot of savings if you take care of your properties and do not have a soft heart. If you let your tenants off easy with late rent they will take advantage of you and it never ends well. If you don’t ever raise rents when rents are increasing it can cost you money as well and decrease your cash flow. If you have a great tenant who pays every month and never asks for anything you may want to keep rents a little lower to keep them around. However I have seen landlords never raise the rent for five years or more and that will cost you a lot of money.
How to increase cash flow by checking your rental properties often
There are many ways to check your rental properties on a routine basis. A simple drive by can tell you a little about a property, but it is best to go inside the home. We replace furnace filters every six months and that helps keep the furnace running well and gives an opportunity for us to see the inside of the property.
If your tenants have a dog that is destroying a home, have a second family living in the property or are trashing the place, an interior inspection will help you take care of the situation quickly. The sooner you catch a problem, the less damage will be done.
How to increase cash flow by raising the rent when market rents allow for it
I just rented rental property number 1. When I first bought the home in December 2010 I was hoping to rent it for $1,000 a month. I ended up renting it for $1,000 and then raising the rent to $1,050 a year later when the first tenants moved out. The most recent tenants moved out last month, and I raised the rents to $1,300 a month due to our smoking hot rental market. We rented the home right away to a tenant who moved in last week. Here is a great article on how to determine market rent.
How to increase cash flow by paying off the mortgage on a rental property
The easiest way to increase cash flow is to pay cash for a rental property, assuming you have the cash. I don’t pay cash for rentals because it lowers my cash on cash returns even though it increases my cash flow.
I like to use financing to purchase my properties and then aggressively pay down one mortgage at a time. I paid off my first rental property earlier this year using this strategy! By paying off that home, I increased my cash flow by $400 a month. Couple that with the $250 a month rent increase, and I am making $650 more a month on that property than I was two months ago!
How to increase cash flow by buying more rental properties
The best way in my opinion to increase can flow is to buy more cash flowing properties. Many people ask me why I use cash flow to pay off one mortgage at a time instead of use that cash flow to buy more properties. In a perfect world where I could get as many 30 year, fixed rate mortgages as I wanted, I would use all my cash flow to buy more properties. Because it gets very hard to finance properties once you have more than four mortgages and more than ten mortgages, I choose to pay off one house at a time. I also use ARMs to finance my properties which is another reason I pay off my loans quickly. I have since changed this strategy however, and now I save my cash flow to purchase more properties as opposed to paying down my mortgages.
Cash flow is extremely important when investing in long-term rental properties. It is important to do your research and realize the houses with the highest price to rent ratios may not always produce the most cash flow. Ease of management, expenses, turnover and vacancies must be considered when figuring cash flow. Your strategy regarding how you finance and pay down mortgages will greatly affect cash flow as well.
For more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook and is an Amazon best seller.