The Truth About Cash Flow for Investment Homes

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Author: Kevin Conlon

Comparing the cash flow of investment properties is difficult, even for experienced real estate investors.   You may have seen a version of these alluring marketing pitches:

      “$3,000 Annual Cash Flow!”        “Get Positive Cash Flow With No Money Down!”        “31% Cash-on-Cash ROI!”   But common sense tells us that things that sound too good to be true often aren’t.  How is an investor to know?  A little basic knowledge and some due diligence up front will go a long way in answering this question.   There are three primary ways that an investor makes money in real estate: from cash flow, property appreciation, and pay down of the mortgage (reduction of debt liability).  Building equity through appreciation and mortgage pay down are generally well-understood; however, the idea of cash flow is much more ambiguous.   Conceptually, it seems simple enough:  cash flow is the difference between the checks you write each month and the checks you deposit. However, many sellers of investment property have a much looser definition of cash flow, or make very unrealistic assumptions about it, and therefore can easily mislead an unwary investor. Most commonly, the key elements of cash flow that are misstated are rents which are overestimated, or expenses which are understated or omitted entirely.

Let’s examine the elements which comprise cash flow with an example.  Figure 1 shows the fundamentals required to calculate the true before-tax cash flow (BTCF).  It assumes a single-family home that is purchased for $80,000 and is rented for $800 per month with a 5% vacancy rate.  Property management is assumed to be 10% of the gross operating income (GOI) and the repair allowance is assumed to be 5% of GOI.  Property taxes and insurance are assumed to be $800 each, with no landlord-paid utilities.  The mortgage is assumed to be at an interest rate of 7.25% fixed for 30 years with a 10% down payment.

About Author: Kevin Conlon is co-founder of Meridian Pacific Properties. Click here to learn all about Positive Cash Flow Properties & Cash Flow Investment Homes Click here to learn more about The Truth About Cash Flow & Positive Cash Flow Properties