Cash Flow Analysis

Investing in real estate rental property requires a great deal of research. One very important aspect of the process is understanding how a property is going to generate cash flow from rental operations.

Are you looking into buying a real estate property? Can’t decide which investment is best suited for you? Why not use cash flow analysis for investment to find the best property?

Cash flow = Total income – total expenses

At first, cash flow analysis looks like a simple calculation of total income minus total expenses. However, after using the equation you’ll realize quickly that it is more complex than it appears to be. Cash flow analysis for investment is a crucial method used by real estate investors. It is used to make a calculated decision when buying an investment property. Successful real estate investors will advice any real estate buyer that the rental income is the main deciding factor.

First-time investors are more likely to overlook certain expenses. Like previously mentioned, cash flow analysis is total income minus total expenses. Determining the total income is relatively easy. Determining the total expenses is more complex. By doing cash flow analysis, the real estate investor determines the total expenses that he/she will experience, thus limiting the surprises that the potential landlord can encounter. Here are four factors to why it is crucial to use cash flow analysis for investment when buying a real estate property.

Pro forma deception

Pro forma analysis data gives the investor an idea of the potential cash flow the real estate investment can generate. It is a good starting location when a real estate investor begins to look into buying investment properties. That’s just it. It is just a start. Pro forma is essentially an estimated cash flow analysis that is created by the real estate seller or broker. Real estate investment is all about making money. As a seller, it is his/her responsibility to get the maximum income potential from the real estate investment. This means that the seller will exaggerate the rental income or neglect to include expenses that decrease his/her revenue. By doing cash flow analysis for investment, the real estate investor takes the power into his/her hands. A thorough cash flow analysis will help determine the proper rental income as well as the monthly expenses. A well-done cash flow analysis for investment makes the investor more understanding of the responsibilities of owning an investment property.

Over estimating the rental income

As a real estate investor, you need to work on a properly thought out cash flow analysis for investment. This will help you understand where the real estate property will make money and where the investment will cost money. An investor will use the 50% rule to assess an approximation of the properties rental income. This method is not reliable, as it can be deceptively high. The 50% rule states that half of the rental income will be spent on the property bills and other expenses. For that reason, it is crucial to use cash flow analysis for investment. Using cash flow analysis for investment will provide the real estate investor with an accurate cash flow for the rental property. Every real estate investment is unique. Each investment property has different maintenance issues and bills. The 50% rule is a generic calculation. It does not account for the extra expenses that are unique to your real estate property. By doing cash flow analysis for investment, the investor has accurate cash flow figures specific to the property of interest.

Using the numbers to your advantage

Cash flow analysis for investment is crucial to real estate investing. It gives exact numbers on returns, such as net operating income, cash on cash return, rental income, etc.  Therefore, cash flow analysis for investment is important. It forces the real estate investor to assess the rental income and the expenses of the investment property. Cash flow analysis forces the investor to do necessary calculations to run a successful real estate business. Net operating income (NOI) = Total income – total expenses The net operating income is the total income that the real estate investment generates minus the expenses paid. This formula leaves the real estate investor with an idea of how much cash flow to expect on a monthly basis. Cash on cash return (CoC) = Cash flow/investment basis Cash flow analysis for investment provides the investor with the rate of returns in the form of CoC.  This is a great method to determine the performance of the property.  A good real estate investment is a property that has a CoC return that is 8% or higher. Doing cash flow analysis gives the real estate investor the opportunity to assess the performance of the real estate investment, determining if it is a suitable property for his/her real estate business.

Budgeting for property management

Another benefit of doing cash flow analysis for investment is for property management. The investor will know how to better manage his/her investment property when a cash flow analysis is completed prior to purchase. Certain costs can go to the waist side and be forgotten: vacancy, gas for transportation, office supplies (for multi family properties), landscaping, etc. When doing cash flow analysis for investment, the real estate investor must take consideration of the non-monthly expenses. There are expenses that do not occur on a monthly basis. They may occur once or twice in the year, which means it is the investor’s responsibility to add a percentage of these bills to the monthly expenses report. For example, if a landlord is expecting a vacancy one month in the year, the landlord can add 1/12 of the monthly rental income to the monthly expenses. Preparation through cash flow analysis for investment limits the surprises that may occur with the property.   Cash flow analysis for investment is a crucial step when buying property. Through logic and figures, cash flow analysis can show the performance of the real estate property. The numbers are capable of giving the real estate investor ease of mind and comfort when buying a real estate property. By using real data and math, the investor can begin his/her real estate business on the right foot. Whether you’re starting your real estate business or trying to expand it, using cash flow analysis for investment is the best tool to successfully grow your real estate business.