Help to understand how cash from rentals works in real estate

How To Understand Cash Flow

When you start to look for good income property values the most important aspect to look at is the "numbers". Needless to say if a property doesn't make money your not interested in acquiring it, right? Maybe you should be.

There are many properties that show a negative cash flow when first looked at. These properties have sellers who are looking to sell off what they consider a losing investment. The reasons they are not making money vary and usually can be corrected with a little thought and work. This can be a very good chance to acquire income property from a very motivated seller!

Some properties have not stayed up with the current market value for rent, which once you acquire them you just raise the rent to meet the market rate.

Others need minor repairs to make them more attractive to renters to keep them fully rented.

Then there is the "other" income that can be obtained with extra services being provided to your renters.

All properties acquired under the right terms can produce a positive cash flow.

When you fill out the cash flow guide form on a property, fill out two forms. The first one will represent the present cash flow of the property. This one will be based on the owner's records and the high side of estimates on everything else. The second form will be based on the improvements, other services, and market rate. Of course you won't let the seller know what the second form tells you!

To find the market rate for rent look in the newspaper classifieds to see what properties similar to this one are renting for in this area.

Next notice how many rentals there are listed in this area and determine the demand for units. (check with the rental locator services and find out from them how many people are looking for rentals in this area, and the whole area over-all, to get an idea of the market demand)

When you do your viewing of the property use your home inspection list to determine what improvements the property needs to make it more desirable.
At the same time notice and record any other sources of income the property has. I know a property that only brakes even from the yearly rent but it generates nearly $500.00 a month in net income from the laundry and snack machines!

Cash Flow Guide Form
Gross income- The total income the property brings in during a year. Included are: Yearly Gross- This is the total rent collected if each unit is rented.
Other income- The amount made from all other services provided. This can be many things including coin laundry machines, soda machines, candy machines, cable TV charges, paid parking spaces, or extra storage areas,�.etc.
Vacancy allowance- The amount of lost income from non-paid rent or empty units. A good figure to use is 25%.

2. Expenses- The amount it costs you to operate your property. Included are:
Taxes- the amount of taxes paid for you property. This includes property, employee, and sales taxes.
Insurance- Include the amount for property and any employees you have.
Utilities- These items are broken down on the form so you can see which item is under your control. If electric costs are high you can have the tenants pay their own bills where possible. If this is not possible as in a large apartment complex with only one electric meter, you can charge a standard electric fee in addition to the rent. People are used to paying the electric bill, so this won't affect your tenant's decision to live there.
Advertising- Any type of advertising necessary to keep the building full. Find out from the newspaper the cost for classified ads and times it by 12. This should be a safe estimate.
Supplies- Everything used to run and maintain your property. This would include office supplies, cleaning supplies and maintenance supplies.
Maintenance- All wages and contract money spent to maintain your property. This would include general cleaning, painting, pest control, repairs, and remodeling you have done. Also any preventive services that are performed.

Unless the seller has extremely good records you will have to estimate an amount to use on your form to cover the maintenance costs. A good formula is one month's rent each year for each unit. This figure is usually high which is the safe side.

Management- Include any costs paid to others to manage your property. This would include any employees or contract services such as management companies or agents. Talk to managers of other comparable properties and management companies to find a good figure.
Bookkeeping- Check the rates with a few different companies to get a general amount charged unless you plan on doing your own books. (still put an amount on the first form)
Miscellaneous- You need to always put aside a given amount to have in case of unexpected problems. A good figure I use is 10% of the net each month.

PayBack- This is the amount of your monthly loan payments. This figure will someday be gone so it is important to remember when you do the forms that this is a long-term investment and you may not make a substantial amount of income while making these pay-backs, at least on paper!

Mortgage payments- Your combined yearly payments. This is where you can change the cash flow amount the easiest.

If the terms of the present mortgage show a negative cash flow then try to get new terms that will give you a lower monthly payment. Example- The seller is offering the property for $100,000 at 9.5% for 15 years, which makes the monthly payment $1,050.00. At these terms you see a negative cash flow of $125.00 a month. If you restructure the terms to go 20 years at 8% then the monthly payment will be $837.00 a month. That�s a difference of $213.00! Subtract out the $125 and you have a positive cash flow of $88.00! That might not look like very much but this is the figure you will use to negotiate with the seller on the first form not the total from the second form, which has the lower costs.

You may wonder why a seller would change his terms to fit your needs like this. If you take the total pay-off over the life of the mortgage the seller will make an extra $13,000. For going along plus they sell their property, which is not making them any money right now.

There are other ways to change the terms based on each situation. Know the situation by knowing the seller and use the possibilities you will learn by searching our web site.

At first you should look for properties that have a cash flow to meet your income needs and wants. Later though you should look for any properties that will give you a high return on your investment dollar not only in income and total profit but also in tax savings.

 

 

 

Cash Flow Guide Form

 

Gross Income:

Annual Income _____________

Other Income + _____________

Total Income =_____________

Vacancy Amount (25%) - ______________

Gross Income Total = ______________

 

Expenses:

Taxes _____________

Insurance +_____________

Water +_____________

Sewer +_____________

Garbage +_____________

Electric +_____________

Bus Licenses +_____________

Advertising +_____________

Supplies +_____________

Maintenance +_____________

Pest Control +_____________

Management +_____________

Bookkeeping +_____________

Miscellaneous +_____________ =

 

Total Expenses - ______________

Operating Income = ______________

 

PayBack:

 

1st Mortgage ____________

2nd Mortgage +____________

3rd Mortgage +____________=

 

Total Mortgage - ___________

 

Cash Flow =(+/-) ___________


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