A common mistake I see newbie real estate investors make is not having a complete understanding of their cash flow. As a result, they don’t set aside enough money for unexpected expenses. Trust me when I say that it’s not a matter of if something will go wrong, it’s a matter of when. So it’s important that you learn how to run the numbers on a potential rental property. If you’re new to real estate, here’s a quick introduction on how to calculate your investment property’s cash flow.

Income

First, let’s start with income. Income is, of course, the amount of money generated by the potential property monthly and annually (the most obvious income being rent). We should do a market analysis, comparing rental comps in the area to see what our rent potential is. Be sure to make comparisons of similar properties. For example, square footage and the number of bedrooms are the two primary factors that drive rent prices in an area, so we’ll want to make sure we’re comparing like properties. Once we determine our baseline rent, then we can start adding in other potential income streams, like pet fees, parking fees, appliance rental fees, etc.

Expenses

Once we understand income, we can move on to expenses. The most obvious expenses are mortgage, taxes, and insurance costs. We should always include potential property management fees as well. I strongly believe that you should hire a good, qualified property manager. Even if you plan to manage the property initially, chances are there will be a time when you will want to dedicate your valuable time to grow versus maintain your properties. 

Don’t forget often overlooked expenses like capital expenditures (capex), operating expenses (opex), and vacancy. Vacancy includes the time it takes for 1) the tenant to leave the property, 2) securing a new resident and 3) any additional “get ready” repairs.

Like I mentioned earlier, a newbie mistake is not setting aside money for these types of expenses. Having reserves for all of these expenses and understanding their potential cost is crucial when deciding on a property and understanding what our cash flow would be.

A general rule of thumb is to set aside 50% of the rental income each month for capex, opex, property management, vacancy, taxes and insurance. Basically, everything except the mortgage. The 50% rule works well because these are unavoidable expenses that will occur over time. It’s why I say always run numbers for property management, even if you think you aren’t planning on using one. Give your future self the option to have a property manager, rather than forcing yourself to assume this full-time role.

Here’s what I set aside:

10% for property management

10% for operating expenses

10% for capital expenditures

5% for vacancies (but this is market dependent)

Taxes are very market-dependent as well. For most markets we’ll set aside roughly .5% – 1% of the property value, so about 10% of revenue that is produced from the property.

Cash Flow

Finally, the number one thing we invest for: cash flow. Subtract all the expenses from all income streams from the property and we’re left with our cash flow.

Here’s a simple example:

Let’s say you rent out a property for $1,000. We can assume based on our 50% rule, you will have to pay $500 (over time) for expenses. Let’s assume that the mortgage payment is $300. That leaves $200 of cash flow each month. (For more in-depth analysis on whether or not this is a good deal and the factors I consider, watch my video here.)

And there you have it! You can practice running back-of-the-napkin numbers on properties in your area today. Practice until it becomes second nature to you. One thing that separates the good from the GREAT real estate investors is the willingness to pass on “okay” deals for the incredible deals. But you’ll only get there by running the numbers on as many potential deals as possible before finding that hidden gem worth investing in.

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