If you’re thinking about investing in real estate, there’s a lot of things to keep in mind. Plus, a lot of numbers to crunch. While it’s important to consider every variable, there are a few simple formulas that will guarantee you’re not making a terrible investment. Enter: positive cash flow and cash-on-cash return. If either of these garner bad results, the entire investment will be a flop. But what are they and how do you calculate them?
Positive Cash Flow
Focusing on obtaining a positive cash flow will help you actually make a profit off of your investment. The idea of positive cash flow is pretty simple: charge a rent higher than your monthly mortgage rate and other expenses. For example, if your mortgage rate is $2,300 a month and you have other rental expenses totaling $200 a month, your monthly expenses will equal $2,500 a month. You’ll need to use this as a basis for how much to charge as rent. Calculating cash flow is as easy as subtraction:
$2,500 monthly expenses – $2,700 rent = $200 positive cash flow
$2,500 monthly expenses – $2,300 rent = -$200 cash flow
If you charge less than your monthly expenses for rent, you’ll have a negative cash flow. If you’re losing money each month, how are you supposed to make a profit?
A positive cash flow isn’t an automatic, “Yes! You made a great investment!” Having expenses of $1,999 a month and receiving rent of $2,000 a month is technically a positive cash flow. But $1 isn’t much of a profit.
A cash-on-cash return is an easy way to estimate how good of a cash return the property will give you. Your cash-on-cash return is your annual cash returns divided by your down payment. For example, let’s say that you make $5,000 off of the property each year and you made an original down payment of $40,000. Then,
$5,000 ÷ $40,000 = .125 → 12.5% return
Most experts think that a good cash-on-cash return is 8-12%. But other investors won’t invest without at least a 20% cash-on-cash return. What qualifies as a “good cash return” differs from property to property.
While positive cash flow and cash-on-cash return are important characteristics of good real estate investing, property investing is much more complicated than that. With the proper research and a great agent, we know you can make the investment of your dreams. Need help finding the property? We can help! (And save you some money in the process, which is always good, if you’re trying to make an investment.)
Brady Miller, CFA is Chief Executive Officer at Trelora, Inc. Brady joined Trelora in August, 2018 as Chief Financial Officer. He moved into his current role later that year and is responsible for all daily operations and growth of the broader real estate business. Prior to joining Trelora, Brady was Chief Financial Officer of Leeds West Groups which is one of the largest, and fastest growing automotive retailers in America. Brady managed their real estate portfolio, financing, human resources, and accounting. He earned a Charted from the CFA Institute in 2016 and holds a bachelor’s degree from the University of Colorado, Boulder where he majored in Finance and Real Estate.