Cash flow is a financial term real estate investors should understand. Most property investors make their biggest mistakes by not forecasting cash flow properly. Cash flow is the profit remaining after all expenses have been deducted. One of the most common errors real estate investors make is underestimating the expenses associated with rental homes.
When calculating cash flow, the PITI formula is used. This acronym stands for principal, interest, taxes and insurance. These are the four components of a mortgage payment that should be allocated as debts when calculating cash flow. The often overlooked expense is maintenance.
Maintenance costs can turn a positive cash flow into a negative cash flow with one unexpected repair. Replacement costs for big ticket items such as air conditioners or a leaking roof can consume budgets and eat up cash flow. Investors have to dip into savings or use profits from another real estate investment to cover the negative cash flow.
It is a good idea to estimate seven to ten percent for routine maintenance when determining cash flow. Investors should also budget eight to twelve percent for a property management company. This expense can be eliminated if the investor lives nearby and can handle small repair jobs. Handling the repair work on their own can increase profit margins and yield a positive cash flow.
Investors who buy homes as rental properties make another investing mistake by setting rent prices too high. The house can remain vacant for months until a tenant is found. This is particularly true if the rent amount is in the middle to high average of other rental homes in the area.
Negative cash flow is generated each month the rental is unoccupied. This cuts into profit margins for the year. It isn’t worth holding out for a higher monthly rent if the unit remains unoccupied for several months.
Cash flow deficits can be eliminated once the property is rented. Charge a lower rent to attract tenants. Increase the rent at each lease renewal until the property is renting at the price you want.
Most tenants won’t want to go through the expense of moving once they live in the home. They would rather pay the increase in rent. This keeps a steady incoming cash flow for your rental properties.
Cash flow can mean the difference between success and failure for your real estate investment business. Plan your expenses wisely. Don’t project too high of a return on your property investments; otherwise it will cut into your cash flow. A sure profit in hand is always better than the chance at a higher profit later.