How to Really Calculate Cash Flow on Your Next Rental Property

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When I was a kid, Duck Tales was one of my favorite TV shows.

Each day after school I’d watch the adventures of Huey, Dewey, and Louie as they fought off the Beagle Boys who wanted good ‘ol Scrooge McDuck’s hard earned money. They always managed the thwart the efforts of the villains and save Scrooge’s money and, as a reward to himself, Scrooge McDuck and the three nephews would take a swim in his vault of money. Yes, you remember. They would jump of the diving board head first into mountains of gold coins. As a kid, nothing seemed more exciting than that.

So how did Scrooge get so much money? To use Scrooge’s own words, by being “smarter than the smarties, and tougher than the toughies.”

In other words, scrooge was good at business. He was smarter than the rest.

Yes, this is only a cartoon, but I think there is a valuable lesson to be learned here. If you want to succeed and swim in your own river of cash, you need to be smarter than the rest. I believe the best way to do this is through a solid grasp on the numbers.

Math is not most people’s favorite subject in school, but it might be the most important for a real estate investor. Understanding how your business makes money is imperative in helping it make more. Therefore, today I want to focus on one of the most important aspects of real estate math: Cash Flow.

In layman’s terms, cash flow is the amount of income left in your business after all the bills have been paid; this amount is often expressed as a monthly dollar amount. In the real estate rental business, cash flow is the income lefts after paying out expenses such as the mortgage, taxes, insurance, vacancies, repairs, capital expenditures, utilities, and any other expenses that affect the property.

How to Calculate Cash Flow

Cash flow might seem really easy to calculate… but trust me, a lot of people get it wrong. At it’s core, it IS very simple.  To calculate cash flow you simply subtract the expenses from in the income:

Cash Flow = Total Income – Total Expenses

Easy enough, right?  So… why do so many people screw this up?

The fact is: while the equation is simple enough, the items that make up the equation are loaded with complexity.  Let’s take a look at both to see what I mean:

Total Income

While the total income might be the same as the total rent, many times it won’t be. There may be other sources of income you need to account for, such as application fees, late fees, and laundry income.  When analyzing a property for cash flow, it’s wise to list out all possible sources of income, but be conservative. It’s best to err on the side of caution and assume you’ll be getting less than you actually hope to.

Total Expenses

Ah… this is when things get complicated. You see, most people can figure out the income, but when it comes to expenses, one mistake can be the difference between incredible success and catastrophic failure. When dealing with rental properties, there are a LOT of expenses you’ll encounter. For example, just off the top of my head, you might have:

  • The Mortgage
  • Mortgage insurance (PMI or MIP)
  • Property Taxes
  • Property Hazard Insurance
  • Flood Insurance
  • Earthquake Insurance
  • Water
  • Sewer
  • Garbage
  • Electricity
  • Natural Gas
  • Propane
  • General Maintenance Upkeep
  • Landscaping
  • Repairs
  • New Appliances
  • Capital Expenditures
  • Office Supplies (stamps, envelopes)
  • Software
  • Gas/Mileage
  • HOA (Home Owner’s Association) Dues and Fees and Assessments
  • City Taxes
  • Advertising
  • Payroll
  • Property Management
  • Vacancy Rate
  • Probably a lot more I’m not thinking of…

To further complicate things, not all expenses are going to occur each month, so it is often best to calculate a certain percentage for those expenses when planning for the future. For example, you may not have any vacancies right now, but you might assume your property will be empty one month out of the year. Therefore, you will want to include 1/12th, or 8.33%, for your monthly vacancy expense.

Some expenses, like office supplies and gas, you may choose to ignore on individual houses, but if you are buying a larger multifamily – I’d recommend including it because it does add up quickly.

Example: Let’s Calculate Carl’s Cash Flow

Carl is trying to calculate his monthly cash flow for a duplex he might buy.

According to the real estate agent, the property will rent for $600 per unit. Carl would be responsible for paying $125 per month for water/sewer and $50 for garbage. He also learns that properties like this duplex in this area sit vacant for 5% per year. Carl assumes he’ll spend 8% per month on repairs. He also will plan on setting aside 5% each month for capital expenditures, such as a new roof, heating system, or other big ticket items down the road. Finally, Carl calculates that his mortgage payment will be $470 per month (taxes and insurance not included.) The property taxes are $960 per year and the insurance would be $600 per year. Finally, Carl will be using a local property management company that charges 10% per month to manage the property.

How much cash flow can Carl plan to receive?

Income:

$600 x 2 = $1200 per month in income

Expenses:

  • Mortgage: $470
  • Taxes: $80
  • Insurance: $50
  • Vacancy: $60
  • Repairs: $96
  • CapEx:$60
  • Water/Sewer:$125
  • Garbage:$50
  • Management:$120
  • $1111 per month in expenses

Income – Expenses = Cash Flow

$1,200 – $1,111 = $89 per month

How to Calculate Cash on Cash Return on Investment

Bonus: If Carl spent $20,000 to acquire this property (down payment and closing costs), what kind of Cash on Cash Return on Investment would this be for Carl?

The cash on cash return on investment is the annual cash flow a real estate investor receives based on the cash they invested. It is one method to compare the returns an investor might get through rental real estate compared to other investment methods.  To determine your cash on cash return, use the following formula:

Cash on Cash Return = Annual Cash Flow / Total Investment 

Therefore, since Carl would be expecting $1,068 per year (with a $20k investment) the formula would be:

$1,068 / $20,000 = 5.34%

Carl’s estimated cash on cash return on investment would be 5.34%.  Keep in mind, this return does not take into account potential appreciation, loan pay-down, tax benefits (or payments), or other forms of increase or decrease in his profit. However, I like to use the Cash on Cash Return because, at minimum, this is what I probably will expect. If the property appreciates or the loan pays down over 30 years… awesome! However, I don’t necessarily base a deal on this.

Let’s move on and give YOU a chance to calculate the cash flow and return on investment.

Your Turn: Calculate This! 

Shirley is considering purchasing a triplex. Two of the units would rent for $600 per month and the third unit would rent for $1000 per month.  She would be responsible for a monthly water bill of $155, garbage bill of $40, and electric bill of $50. The property taxes would cost her $1392 per year while the insurance would cost $936 per year. She will plan on setting aside 10% for repairs, 5% for CapEx, 12% for property management, and 10% for vacancy. Finally, Shirley will be putting down $35,000 to buy the property and obtaining a mortgage that will cost her $586 per month.  

How much Cash Flow can Shirley plan to receive, and what Cash on Cash Return on Investment would that be? 

Cash Flow Answer:

Screen Shot 2014-06-13 at 8.55.39 PM

How did you do? Let me know in the comments at the bottom of this post if you got it right!

How to Calculate Cash Flow Using the 50% Rule

Another, much quicker way, to estimate cash flow is using a technique known as the 50% rule. This rule of thumb states that a rental property’s expenses tend to be about 50% of the income, not including the mortgage principal and interest (P&I) payment. The formula would look like this:

Cash Flow = (Total Income x .5) – Mortgage P&I

Let’s use the same information we used earlier with Carl and the duplex he was interested in. In that example, the property was expecting to bring in $1200 per month in income, with a mortgage P&I of $470 per month.  Using the 50% rule, we can see:

  • Cash Flow = ($1200 x .5) – $470
  • Cash Flow = ($600) – $470
  • Cash Flow = $130

Keep in mind – the 50% rule is only a rule of thumb and generally not as accurate as using the actual expected numbers. In this example, Carl determined using the 50% rule that he could expect $130 per month in expenses, but the actual numbers we did earlier showed only $89 per month.

Therefore, the 50% rule is a good tool to use to quickly analyze a rental property, but should never take the place of a thorough analysis of a property. Think of the 50% rule as a “quick filter” that allows you to estimate cash flow in under a minute, enabling you to analyzing dozens of properties looking for a deal with potential that you can run a more thorough analysis on.

Finally, it would be a shame not to mention that all these numbers you can do online using the BiggerPockets Rental Property Calculator.  While you can easily do these numbers on a spreadsheet or on the back of a napkin, I find it helpful to use the online calculators to ensure my math is correct and that I’ve considered all the potential expenses. Furthermore, you can save your analysis reports and even print out your report to give to potential lenders, partners, or others.

Check out the video below to learn more about the rental property calculator:

RentalPropertyCalculator from BiggerPockets on Vimeo.

To check out the BiggerPockets Rental Property Calculator, and all of our other online analysis tools, go to BiggerPockets.com/calc.

What do you think? Did you get the answer right? Let me know if you have any questions or comments by leaving me a note below! 

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About Author

Brandon Turner (G+) is the BiggerPockets.com Senior Editor and Community Director. He is also an Active Real Estate Investor (Flips, Apartments, and Buy-and-Hold), Entrepreneur, World Traveler, Third-Person Speaker, and Husband. Come hang out with him on Twitter!

36 Comments

  1. You lost me here:
    “Therefore, since Carl would be expecting $1,068 per month, or $2,220 annually, the formula would be: $1,068 / $20,000 = 5.34%”

    Don’t you mean to say, since Carl would be expecting $89 per month, or $1,068 annually,…?

    • Brandon Turner

      Oops! Sorry Curtis, I left in that $2200 number but meant to write “$1068 annually on a $20k investment.” The cash on cash would still be 5.34% – ignore my “2,220” number in there! :) That’s what I get for writing a post at midnight!

  2. Arthur Banks on

    I think there is an error here. You stated: Therefore, since Carl would be expecting $1,068 per month, or $2,220 annually, the formula would be: $1,068 / $20,000 = 5.34%”

    Wouldn’t Carl’s annual income be $1068 if the monthly is $89?

  3. I remember being really excited about the gross rent we were going to collect when we bought our first multi-family and then amazed at how many expenses there were. Not to mention some unexpected expense is going to come up on a pretty frequent basis. I actually took the online calculator a step further and put into a spreadsheet. I talked about it and have screen shot here: http://beta.biggerpockets.com/blogs/4970/blog_posts/36159-a-spreadsheet-jump-started-my-investing. This allows me not only to calculate the cash on cash return for a property but also compare that property to others in the market. I can also change my assumptions (interest rates, down payment, management fees, etc) and it will automatically adjust the numbers for all of the 150+ properties.

  4. Show-off!!!

    However, I really am starting to notice that the 2% and 50% “rules” a wildly misused by newbies. This has always ben evident, but lately I’m seeing some asinine applications of these. Brandon – I think that may be it’s time to begin distancing from those.

    Here at BiggerPockets we teach fundamental investing principals – investing the right way, so to say. These “rules” are getting in the way of people’s fundamental logic.

    None of the seasoned people I know and talk to on a daily basis, such as Serge S, Brian Burke, or yourself, would dream of wasting a minute of thought on these “rules” – they are by and large meaningless. I think we need to be done with those…gonna write a post next week about this and blame you for everything :)

    • Brandon Turner

      Now Ben… if you’ll do more than just Skim my posts, you’ll see that this post was designed to show how the 50% rule DOESN’T work. But now that I know you only read my headers, I’ll start telling all your secrets within my posts ;)

  5. You’ve got some wonky math there, Brandon:

    “Cash on Cash Return = Annual Cash Flow / Total Investment
    Therefore, since Carl would be expecting $1,068 per month, or $2,220 annually, the formula would be:
    $1,068 / $20,000 = 5.34%”

  6. My favorite teacher, when it came to in-depth analysis, once told us that it’s all about following the evidence, just like a detective in an investigation. The numbers at that point take care of themselves.

    Experience has shown me countless times, that with precious few exceptions, residential income properties, especially 2-4 units, rarely have vacancy/expenses exceeding 50%. If they do, you’ve compromised on one or more of the fundamentals. Good stuff, Brandon.

  7. I use the 50% rule when I come across a property that has no data, such as a foreclosure or estate sale. This way I can tell in 1 minute if it’s worth looking at or is overpriced. I’m also building a database of expenses for my current buildings to help me estimate what the expenses should be once I have the building up and running. If the building is worth my time, I plug these numbers in to get a more accurate value.
    It’s amazing how many investors don’t know how to calculate NOI. Hopefully, they will read Brandon’s article!

    • Jerry Kaidor on

      I mostly buy multifamily….
      …and it’s amazing how many property owners don’t know how to track expenses. I can’t count how many times my broker and I have gone to analyze a property, only to be given a single number ( “the expenses are $178K a year” ) or a shoebox of receipts.

      I have developed certain rules of thumb. Given a city I’ve done business in before, I know what the water/sewer/garbage will cost. A quick email or phone call to my insurance broker gets me the hazard insurance cost. Property tax is a simple percentage of the purchase price. Certain cities have extra taxes that they tack on with names like:
      * Emergency Services Tax
      * Fire permit
      * Rental inspection program fee
      * Rent control fee
      * Alarm permit
      * Business Tax ( pretty much everybody charges this )
      ….but these are generally not very high.

      I generally budget for four evictions a year. And do my best to make it less than that.
      The big variable is usually maintenance and repair, which is closely related to the amount of turnover.

      A great help is if you can see the seller’s Schedule E. Even a lying cheat may hesitate to lie to the government.

  8. Great blog, Brandon. Love the break down of expenses in detail and how you kept it small to a duplex as apposed to a 20unit +. Since most investors will purchase a 2 to 4 unit in the beginning so its more realistic. Thanks as always, great job. :-)

    Kudos,
    Mary

  9. Marlene Diaz on

    Thanks, Brandon. This was extremely helpful for someone like me (I have a math allergy.) Your case study walked me through the steps, and I got it right!

  10. Great Post Brandon! It seems everytime I am looking for something in RE investing you post a great article to what I was looking for answers. Your site is great. Thanks again.

  11. Thanks so much Brandon,

    I messed up the first time (forgot garbage) but then got it right. just goes to show how careful you have to be. Keep up the great articles. They REALLY HELP!

  12. Nice job, Brandon.

    You managed to make the “numbers” subject more lively by making the post interactive. That is, you let the reader calculate cash flow on their own and then click to see if they had found the right answer.

    One must know how to calculate cash flow. Cash flow is what gets one out of The Rat Race. Well done.

  13. You forgot depreciation as income. Carl may only “make” $89/month, but he gets to deduct 1/27.5th of the STRUCTURE value each year,
    Imagine the structure is worth $70k…
    Each month Carl gets $89 income AND he gets a net bonus of $1477 in tax write-off.
    (annual depreciation is $2,545 – 1068 net income, leaves $1477 in “bonus” depreciation, since we assume that Carl’s repair budget keeps up with actual wear & tear & repairs)

  14. Very good piece Brandon.
    If you can’t calculate your cash flow you are likely to have some issues going forward as a rental property owner!
    Some things are hard costs you can get easy, some are hard costs that are harder to get but possible, and some will just be best guesses (repairs and CapEx mostly).

    I do like the 50% rule as a quick screen. If I use that and the place isn’t close to my criteria I won’t waste more time on it since it would have to have abnormally low expenses to have any chance of working. If it looks promising I do the more rigorous analysis to see if it still looks good. I have actually been using the higher of “real” and 50% since I figure if it is close to 50% (like high 40s) it’s okay to have the cushion and if it was less then that I must be missing something. :)

  15. Hi,

    I could be wrong and probably am, but in the following paragraph:
    “Keep in mind – the 50% rule is only a rule of thumb and generally not as accurate as using the actual expected numbers. In this example, Carl determined using the 50% rule that he could expect $130 per month in expenses, but the actual numbers we did earlier showed only $89 per month.”
    I believe 89$ and 130$ per month are cash flow figures, not expenses? Cash flow is net of expenses right?

    Thanks,
    Harrison

    • Brandon Turner

      Hey Harrison, I think you are right! I meant to say “$130 per month in cash flow, but the actual numbers we did earlier showed only $89 per month.” Oops! Thanks for pointing that out :)

  16. Brandon, thanks for such an awesome article with real life examples. This one is going in my bookmarks bar for future reference.

  17. I’m looking at a Homepath duplex and currently trying to calculate the cash flow. I’ll be living in one of the units so do you think I should include my “rent” in the analysis to get a better picture? (Otherwise, it’s negative cash flow). Also, how should I go about getting an idea of what the expenses are in that area? To get an idea of rent costs, I’ll be knocking on doors this week to talk and ask. Should I do the same with their expenses? There are not many duplexes in this area so the comps are outdated.

    • I’d think for a duplex you’d want to run the calculations as if you were renting both halves, but make sure to look at your personal budgeting to make sure the “rent” you would be paying is in line with what you can afford.
      examples;
      a) rent on each half of duplex is $700, you are currently paying $750/mos rent in an apartment — Mortgage, taxes, etc are $1k/mos total = go for it!
      b) You are currently renting for $1k. TOTAL costs Mortgage+ insurance, taxes, etc. = $2k. Duplex rents at $1k per unit= use caution. In effect you’ll be having to pay for repairs, vacancies, etc for BOTH units out of your own pocket. Fine if you can afford it not so good if you live paycheck to paycheck. A duplex is often an excellent idea, but it isn’t “free” housing.

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