3 Things to Keep in Mind About Cash Flow
I’m betting cash flow is a phrase you hear thrown around a lot. Sounds about right, since this is something that every single buy-and-hold investor I know is concerned with. That money that they’re making (or losing) each month on their rental property is of primary importance, and often the best indicator of whether or not they’ve made a solid investment.
And just to clarify real quick, here’s what cash flow is:
Total income minus total expenses = cash flow
That is cash flow at its simplest. Like everything, though, it’s not that simple. There are other things you must understand when analyzing a property’s cash flow potential, and that’s what we’re going to delve into now.
- Cash flow is what matters most for buy-and-hold investments. For long-term ownership of a rental property, it’s all about the cash flow. However, lots of investors get caught up thinking about some of the other ways they can make money off their property – namely, appreciation and equity. While these are certainly positives, they’re not going to help you in the here and now. For that, you need positive cash flow each month. If you’re not getting that, you’re losing money, and appreciation and equity become non-factors when you’re losing hundreds of dollars or more each month. Yet, there are investors that seem content with this and tell themselves that lost monthly income doesn’t matter because they’ll “make a lot when they sell.” If that’s your strategy from the get-go, fine, I guess. But for the average investor, this just seems way too risky. Positive cash flow is where it’s at, friends.
- There isn’t an “ideal” amount. For some reason, some investors get it in their heads that a property must produce x amount each month in order for to be considered successful. Well, that’s just silly. Assigning a set figure and then using that as your barometer of a successful investment doesn’t make any sense because IT’S ALL RELATIVE. What’s considered great cash flow in one market might be considered terrible in another. Plus, you have to think about how much you’ve put into a property. If you’re into it for $200,000, getting $200/month in cash flow might seem low; however, if you’ve got a $75,000 house, that $200 could be a pretty sweet deal. Bottom line: Don’t base your decisions of a set number. Cash flow is much more complicated than that, and you have to factor in all the other stuff like market conditions and purchase price.
Cash flow needs to be sustainable. You need to ask yourself, “How long is this cash flow likely to continue?” Because at the end of the day, cash flow is only a prediction. There’s no guarantee that you’ll make x amount of dollars, or that you’ll continue to make it for a certain period of time. The market could tank, your tenants could suck, or a natural disaster could strike. All of these things are (mostly) outside of your control. And that’s why it’s VITAL that you make the smartest and most realistic predictions you can, and add some safety measures, too (emergency account, buying with an LLC, etc.).