I say investing in rental properties is one of the best investments you can make. Real estate generally appreciates 1% above inflation, and it’s a way of gaining passive income. Meaning, you can earn money without having to work. I use the term work lightly.
Depending on the type of landlord you are, you could find yourself working extremely hard. Some landlords do everything! This includes finding, fixing, renting, ongoing maintenance ecetera and ecetera. Landlords who perform all the real estate tasks work very hard and in my opinion for little savings or gain. These type of landlords also are not gaining a passive income. How is your income passive if you’re working 10-60 hours a week on your real estate empire? Passive income to me means, if I’m not involved the checks keep coming.
I am a 100% passive landlord. I spend a maximum of 30 minutes per month performing real estate activities. The 5th of every month I review a very detailed property report from my property manager. If I find any discrepancies I call him or email him to work it out. My last statement took 5 minutes to review!
So how did I get to the average of 30 minutes if it only takes 5 minutes to review the statement?
The majority of my time spent performing real estate activities occurs during the buying process. This includes identifying, purchasing and fixing the property. Before buying I generally know what I can receive for rent. With my rental estimate numbers in mind, I know an acceptable total cost (purchase + repairs) for which I will pay for my next property. With that number in mind I receive reports from several real estate agents for properties in my price range. I also contact wholesalers to identify properties. This takes the most time!
Once we identify 3-4 properties we move quickly. My property manager who was an construction manager goes to each property to determine if it is a neighborhood he will work in. Once the neighborhood test is passed. He performs a full inspection of each property to identify things we need to fix. The inspection is crucial! He provides me a detailed report with pictures of every inch of the house and the associated problems. I use his results to negotiate on the price of the home.
Once I analyze the inspection report, we send in an offer. This offer is typically low and we make sure we site all the issues identified. Negotiation takes on average 3 days. I buy in all cash and we move quick. We do not wait for other offers we give 4 hours for the seller to respond or we kill the deal.
After the closing, my property manager completes the identified fixes. My leasing agent finds the tenants and the checks start to roll in. Once we receive the first rental check we pull 70% of the equity out of the home to perform the next deal. So technically, we only needed to have cash for the 1st deal. Each subsequent deal is reliant on equity from the last deal.
I forgot to add one thing. I live in Virginia and my properties are 540 miles away.
Now that you have a primer on my real estate process how do you know if a rental property is earning? Basically you just have to calculate the cash flow. A property’s cash flow determines the actually money that comes in and out of the business.
Calculating the cash flow of a business involves carefully looking at every income and expense of your property. In order that you won’t miss out on essential numbers, you can make a comprehensive list of the areas that can either put money to your account, or take money out.
Calculating Cash Flow
There’s a simple formula that I use in order to come up with the total cash flow of my rental properties. If it is not earning, I can also determine how much money I am losing per month. The simple formula is presented below:
Rental income – Vacancy Loss – Payments – Expenses = Cash Flow
As you can see, there are 4 elements in my formula. Familiarize yourself with each element so you can come up with the figures.
- Rental income
The rental income simply means the amount of rent that I charge my tenants. For example, rental property 1 I am charging $925 per month. Annually that will be $11,100. This is the property my property manager from hell found for me. What he lacked in professionalism and property manager skills he made up for it in identifying all start properties.
Total Rental Income per month: $925
- Vacancy Loss
To be realistic, vacancy loss should be taken into account. This means that at any time, some of my properties may not be occupied or there may be a possibility of default. This of course means less income for me. I suggest you make your vacancy loss very conservatively. I use 10%. Fortunately, I haven’t had to use my vacancy loss fund, but it’s good to have. 10 % of $11,100 is $1,110 annually.
Total Vacancy Loss per month: $92.50
Of course, my rental properties are not free of some form of payments. There are payments to be made that come in the form of taxes, home equity line of credit (HELOC) and insurance payments. My tax plus insurance amounts to $166 per month. Multiply that by 12 to get the figure of $2,000 per year. My other payment is $130 per month for the HELOC on property 1. My HELOC payments equal to $1,560. Bringing my total monthly payments to $296.67 per month.
Total Payments per month: $296.67
Aside from calculating income, it’s of course very important to take proper note of monthly expenses. Note how much you spend for electricity and water (if you are shouldering these) and other maintenance cost that you might have.
The Landlord tenant laws of my area specify that I have to pay for water. At first I was taken back by this, but I got over it since I do not have to provide any appliances in the rental. My tenants bring their own appliances. Talk about avoiding a headache. I would gladly pay the $50 every 4 months for water over providing appliances.
The other expense I have is a 10% property management fee. This is a fee worth paying. My property manager is integral to the success of my real estate business. He’s the reason why I only spend 30 minutes a month performing real estate activities. He provides a value that is 30x his fee. I also subtract 10% for future maintenance. You can never be too safe! Something will always go wrong with the property.
Once I have each element, I can now calculate just how much cash flow I have every year. Divide the number by 12 and I have my monthly cash flow. It is possible that you will have a negative cash flow. That’s when your expenses exceed your income. My 10% maintenance fee and property management fee are of gross rents received. So, since I receive $925 per month in rental income. 10% of $925 equals $92.50. Also, I pay $150 a year for water, making my average monthly water bill $12.50.
Total Expenses per month: $197.50
If you are experiencing a very low cash flow or worse, a negative one, there’s no need to keep on worrying because there are ways in order for you to increase your cash flow. There are two steps that you can take, first, you can choose to lower your expenses, or you can increase your income.
Monthly Cash Flow: $925 – $586 = $339.50
Not a bad return at all for 30 minutes per month worth of work. Factor in depreciation and I can really buff up these numbers.
Calculating the cash flow of a rental property is vital before you decide to purchase it. This is also very crucial for those who already have rental properties because it helps you keep track of whether or not their investment is really earning or if they are already losing money.
For those who are thinking about acquiring a rental property, aside from checking the potential repairs of the building, it would help to ask the previous owner just how much he is earning per month, the expenses the building incurs, and other information that can help you calculate the cash flow of the property. Better yet get proof of income received by asking for the properties rent roll or rent deposits.
Tell me about your real estate process and your monthly cash flow.