It has been said that you should look at 100 properties, make an offer on 10, and purchase 1 in order to find a great deal. That means a lot of time spent analyzing properties for cashflow, making it a good thing to do faster. Here is a great way to quickly estimate the cashflow and decide if you should move on or if the property is worth looking into more. To estimate cashflow, you simply need to estimate your expenses and your income then subtract them from each other. Your income is the rent, and your expenses are mortgage payments, maintanence, repairs, etc. What is the quickest, whilst still reliable enough to be a good estimate? Here’s what I do:
First, we need to know how much income the property will provide. Usually the only source of income is rent, but sometimes there are others. I’ve seen someone renting a garage for $75/month. You probably already have an idea of the average rent in the area is, so you could just estimate rent by multiplying the average rent by the number of units. Of course, you could simply just add the rents of the separate units together too. I’ll leave this up to you. It is a good idea to check the local ads (like the newspaper, kijiji, craigslist), and perhaps ask the owners of other properties being rented around the area if you can contact them. For example, a 3 unit house renting at around $700 per unit will bring in $2100 per month. It is a great idea to account for vacancy rates in this number too. I have been using 10% vacancy rates, which is a little over 1 month per year of vacancy. Thus, in this case I would use $2100 x 90% = $1890 for my monthly rent estimate.
Now we need to estimate our expenses. First we will calculate our operating expenses. Now, there are a lot of other expenses related to owning a rental property that are nigh impossible to predict. Your tenant kicks a hole in the wall? $150. Furnance bites the bullet? $4000. Can’t find a tenant? A month of rent lost. Roof falls apart? $500. You can’t predict these well, but there is a great rule of thumb for estimating these expenses. I came across this rule of thumb on the forums of www.biggerpockets.com, so credits to them. It is called the 50% Rule. It states that on average, all of your operating expenses like repairs, maintenance, taxes, and insurance will be 50% of your gross rents. I like to use the 50% rule since it is backed by professional real estate investors with over 20 years of experience and many rental properties. Keep in mind that this may not be the case for our particular rental: we may do better, and we may do worse. Be diligent in your home inspections, maintenance, and tenant screening to avoid surprises! I will be using it since I have no experience, and trust these experienced investors. Perhaps I will change it to suit my needs as I see fit! Using this rule, calculating your operating expenses is as easy as dividing your rents by 2, so using the $1890 rent estimate above, our operating expenses are $945. You can calculate Net Operating Income (the money available to pay your mortgage and provide cashflow!) by taking your gross rent and subtracting your operating expenses. In this case $1890-$945=$945. You can just skip this step in the future, and know that your NOI is half of your gross rents.
The last calculation that needs to be made is your mortgage payment. This can be tough to estimate since there are 3 variables involved in calculating a mortgage payment. They are the financing amount, interest rate, and amortization period. I like to use a mortgage calculator. You can find some great ones online. Here’s a good one. There is one important thing to note when calculating cashflow: When calculating your mortgage payment, always calculate it as if you received 100% financing, even if you will be providing a downpayment! Otherwise, you are forcing cashflow. Increasing your down payment will increase your cashflow, but at the expense of a lower ROI! You are essentially buying more cashflow with your money. Real Estate is known to be an OPM (Other People’s Money) industry. Keep as much of your money out of the deal by using leverage, so that you can purchase more properties. This will result in the highest return on your cash. Now, say I’ve taken a loan out for $150,000 at 3.19% and a 25 year amortization to purchase the example triplex. My payments would be $724.57. If my NOI is $945, then my cashflow is $945-$724.57 = $220.43. That means I am getting a monthly cashflow of $220.43, or $73.47 per unit. This is good, but not great. I aim for at least $100 per unit.
Cashflow = (Rental Income/2) – Mortgage Payment
Aim for a cashflow of above $100 per unit.
This should help save some of your valuable time!