If you’ve been learning about or involved in real estate investing for any amount of time, you’ve no doubt heard the term “cash flow.”
Cash flow is important. We can all agree on that. The problem is not everyone can agree on what it really means.
What Is the Definition of Cash Flow?
Cash flow is defined as how much money is leftover after all expenses are paid on a rental property.
However, the issue become slightly complicated when you take into consideration that not every investor uses the same formula for calculating it.
Some people take the rent, subtract the monthly expenses, and call that cash flow. But this formula does not include random expenses you cannot see coming—things like repairs, vacancies, and big-ticket items that need to be replaced like roofs and air conditioners.
The danger with not including these items is you may start spending the cash flow you’ve been generating. Then you’ll find yourself without anything left to pay for repairs or vacancies.
When others describe cash flow, they include every expense they can think of—vacancy at 10 percent of the gross rent (even if vacancy doesn’t occur very often), repairs at 10 percent of the gross rent (even if the lease says the tenant has to pay for repairs), and so on.
The problem with this formula is that it can make real estate investing seem unprofitable. If something doesn’t seem profitable, people won’t spend time pursuing it.
So which is the best way to calculate it?
How Does Cash Flow Work?
First, you need to identify why you’re asking this question. In general, there are two uses for cash flow.
- The first is to have extra money to spend. People who see cash flow this way are often looking to retire early through real estate and need cash flow to supplement their W-2 income.
- The second is to protect your investment. People who see cash flow this way want to make sure they are making enough money to pay for the property’s expenses—but that’s all. They keep anything extra in a reserve account. This line of thinking looks for wealth to come in property appreciation and loan pay down, not through income the property generates.
So who’s right? A lot of it depends on the individual person’s financial situation, investing strategy, or the property itself.
Why Is Cash Flow Important?
What’s important is getting very clear with yourself. What’s your purpose in investing?
Do you want to retire early? Do you want a higher return on your savings? Do you want to hold property long-term for huge appreciation gains? Do you just need a tax shelter?
Real estate has so much to offer—unfortunately, none of it is one-size-fits-all.
Once you understand your purpose, it’s much easier to determine what kinds of property you should be buying, how much you should be spending, and which strategies you should be utilizing.
Cash flow can mean different things to different people. But we can all agree it’s the money you make from a property’s rent after the expenses are paid.
As you continue to learn more about real estate, pay careful attention to the formulas we use to determine how much a property will cash flow—or if it will cash flow at all. As a general rule, never buy a property that doesn’t cash flow unless you have enough income coming in that you can afford to run at a deficit for a long period of time.
To sum it up:
- Only buy properties that cash flow positively.
- Know the reason why you’re investing and what your goals are.
- Understand that cash flow is not a standard term that means the same thing to everyone.
Hopefully this provided some clarity about what cash flow is, how it works, and why it’s important. Watch the video above for even more information!
What else should investors consider when thinking about and calculating cash flow?