How an Income Property Investment Makes You Money: Part 1, Cash Flow
The successful real estate investor never regards a real estate investment like an immediate member of the family. Real estate is not purchased, held, or sold on emotion; it’s not love that compels, it’s all about a return on investment. So the prudent real estate investor will always consider several basic returns to determine the potential benefits of purchasing, holding on to, or selling an income property investment. And being able to understand these investment decision basics, where they come form, and how to calculate them is at the root of real estate investment success.
We will discuss all these basic returns in this multi-part series, beginning with cash flow (sometimes called the “bottom line”). By this, referring to before-tax cash flow, not the amount of cash flow that’s left over after you pay your income taxes on the property’s earnings (or the after-tax cash flow sometimes labeled “net spendable cash”).
1. Cash flow. How much money comes in from rents and other income, and how much money goes out for operating expenses and debt service (loan payment) determines what a property’s cash flow is. Simply put, cash in minus cash out equals cash flow. When more cash comes in than goes out, the result is “positive cash flow” you can pocket. On the other hand, when you have to spend more than you take in, the result is “negative cash flow” that requires you to dig into your pocket and feed the property. The goal, of course, especially for the small investor without deep pockets, is to be sure the property always produces enough cash to pay the bills. So run the numbers.
When looking at a property to purchase, for example, one popular method is an annual property operating data (APOD). It will create a virtual “snapshot” of the property’s income and expenses for the first twelve month period, and when realistic income, expense, and loan data is feed in, the APOD will provide you with the bottom line (whether positive or negative). It’s only one part of a good rental property analysis, but it does offer a quick and easy way for you to at least project and judge whether you might want to pursue a purchase or not with less chance you might get unpleasantly surprised later.
A sample annual property operating data (APOD) is available if you would like to preview one. We’ll continue this series next time. Stay tuned.
