How To Calculate Rental Property Cash Flow

Real estate investing can provide you with an additional stream of income, helping you build wealth and reach your financial goals even more quickly.

One of the most popular ways to invest in real estate is owning a rental property.

Whether you’re a new investor considering real estate or a rental owner trying to decide on your next step, there are a few common goals every real estate investor should have.

To determine whether investing in rental properties is a worthwhile source of passive income, you need to consider these goals and weigh the real-life pros and cons.

Goals for Creating Passive Income with Rental Properties

Want to make the most of rental property investing? 

While your individual goals for real estate investing might differ from someone else’s, here are some common considerations to help you find success.

Understand the Definition of Passive Income

By definition, passive income is money you earn through a venture that takes little to no time or effort to keep up.

Truly passive income lets you put the least amount of hours in and get the most amount of money out.

While investing in rental properties is lucrative and comes with a range of benefits, it can also require some time, money, and effort.

In other words, it’s active. But if you understand the cost and have some of those resources to spare, it can be well worth your while.

And the further along you get, the less hands-on you can be, if you choose.

Do Your Research

You shouldn’t walk blindly into real estate investing. Before you purchase a property, you need to do some pretty extensive research.

This could include:

  1. Exploring the local housing market
  2. Reading up on right to privacy,  discriminatory housing, and eviction laws

Laws regarding landlords and tenants can vary from state to state, so it’s crucial to educate yourself on policies in your area.

Violating one of these laws could result in your tenant taking serious legal action against you.

There are plenty of online resources and courses that can educate you on these laws and help you decide whether real estate investing is for you.

Buy at the Right Time

Seasoned investors may invest in real estate while carrying debt as part of their investment strategy, but should you?

If you’re newer to investing and looking to dip your toe in a few passive income streams, you may want to pay off your debt before investing in a rental property.

While you don’t necessarily have to be completely debt-free to buy a rental property, this type of investment isn’t a good call when you’re weighed down by student debt, medical bills, or extensive credit card debt.

Focus on paying off your major debts and building up an emergency fund before you dive into rental investing. Also, work on saving as much you can for the down payment.

Consider the Costs

There are a few expenses you can expect to pay when you own a rental property. 

Be sure to factor these in as you assess the ROI(return on investment):

  • Property tax: Annual property taxes are a given, whether you live on your property or not. You can use your county tax assessor’s website or online tools to gauge a property’s tax rate.
  • Landlord insurance: This type of insurance protects you from financial loss with property and liability coverage. While it might not be legally required, it’s almost always a good idea to purchase a policy.
  • HOA fees: Depending on the type of property you purchase, you might also be responsible for monthly or annual homeowners association fees.
  • Maintenance: It’s up to you to make sure your rental property is in tip-top shape. Don’t forget to factor the cost of maintenance and upkeep into your expenses.
  • Mortgage: If you aren’t buying the rental property outright, you need to consider the cost of monthly mortgage payments and ensure that you can easily manage them. A mortgage calculator can help.

Note that mortgage requirements are stricter for rental properties than primary residences. 

As such, you’ll have to make a 20-30% down payment, at minimum.

Factor in Time

In addition to money, you also need to consider the amount of time you’ll need to invest.

From learning the ins and outs of real estate investing to managing the property and dealing with tenants, owning a rental property takes time.

One way to free up some time and make real estate investing more passive is to use a platform like Roofstock.

You can buy and manage properties yourself or purchase a turnkey home that comes with certified property management, allowing you to step out of the day-to-day administrative tasks.

Learn How to Calculate the Cash Flow 

To determine how profitable your investment will actually be, you need to calculate your NOI, or net operating income.

Annual Net Operating Income = Annual Rent Collected – Annual Expenses

Knowing the property’s cash flow can help you make important decisions, like whether or not to buy more properties, refinance the mortgage, or pay it off. 

If your NOI isn’t quite as high as expected, you may also decide to sell the property.

In addition to checking up on your current investments, you can also calculate NOI on a property you’re interested in. 

If you’re analyzing a rental property for purchase, you’ll have to estimate your rental income and expenses. 

For a conservative projection, assume a vacancy rate of 10%. You should also consider the age and condition of the property to estimate repair costs. 

Check out comparable properties in your area and factor in supply and demand to set your rental fees. 

There are several online resources to help you appraise the property and estimate its potential rental income.

Choose the Right Property

One of the biggest keys to success in real estate investing is picking the right property to purchase.

If you’re going to manage the property yourself, it’s ideal to choose a home in your area. Otherwise, you can broaden the search.

Here are a few additional factors you should consider as you sift through properties:

  1. Area: Choose a home in a desirable neighborhood whose real estate value is increasing. You may also factor in crime rates, transportation access, the job market, amenities, and proximity to schools.
  2. State of the home: Fixer-uppers are great for flipping and selling, but you should probably buy a rental home that’s close to move-in ready, unless you can renovate it affordably and quickly.
  3. Cost: The pricier the home, the more costly it will be to maintain. If you’re new to rental investing, buy a modest home in a good area, opting for middle ground rather than the nicest or dumpiest house on the street. And don’t forget to factor in property taxes.

Pros and Cons of Rental Property Investing

Investing in rental properties can be very rewarding, but there are also some drawbacks to consider.

Here are some real-life pros and cons of investing in rental properties to earn passive income.

Pros

  • Appreciation: If you choose your property wisely, it should become more valuable over time. It’s a tangible asset that you can improve.
  • Inflation protection: Real estate value increases as inflation does. As your property value increases, your mortgage rates do not, allowing your cash flow to grow.
  • Tax benefits: The IRS does not put a self-employment tax on rental income, and rental properties come with tax-deductible expenses.
  • Consistent cash flow: Renting can provide you with a steady flow of somewhat passive income, especially if you have long-term tenants.
  • Equity: Every rent payment you collect makes you wealthier. You get equity, while your tenants basically pay your mortgage for you.
  • Leverage: With rental properties, you get to use borrowed money to own a sizable asset and build your wealth, only having to invest the down payment.

Cons

  • Costs money: Investing in rental properties cost money upfront for the mortgage and closing costs, and down the road for upkeep, taxes, and insurance.
  • Liquidity: Rental investing is a long-term investment. You’ll have access to cash flow each month, but there’s no guarantee you’ll be able to sell quickly if you need to liquidate.
  • Learning curve: Before you can successfully start investing in rental properties, you have to learn about landlord laws, the local housing market, property management, and calculating cash flow.
  • Landlord duties: Unless you use a property management company, you’re on the hook for dealing with difficult tenants, collecting rent, and keeping the property up.
  • Not truly passive: While rental investing is rewarding and you can hand off a lot of duties to a property management team, it isn’t the most passive form of income.

How to Calculate Rental Property Cash Flow or NOI

With a better understanding of what goes into successful real estate investing and the pros and cons, here’s a look at an actual cash flow analysis.

The summary below is for our first home, a townhome we converted into a rental home in 2012.

I manage everything through a single Chase checking account, which lets me download all of the previous year’s data into a spreadsheet.

If you have multiple properties, it might be helpful to use a more sophisticated expense tracking tool. I recommend the tools from our long-time partner Cozy.

Here are my specific numbers from last year.

Cash Flow (aka NOI) Analysis

Rent Collected

  • $2,200.00 January Rent
  • $2,200.00 February Rent
  • $2,200.00 March Rent
  • $2,200.00 April Rent
  • $2,200.00 May Rent
  • $2,200.00 June Rent
  • $2,200.00 July Rent
  • $2,200.00 August Rent
  • $2,200.00 September Rent
  • $2,200.00 October Rent
  • $2,200.00 November Rent
  • $2,200.00 December Rent

Total Rents Collected $26,400.00 by check

This was our best year of rent collected yet. We raised the rent slightly last year and it’s nice to see a full year of collections at the new rate. 

We’re blessed with an excellent tenant who pays on time by check each month. Unlike the year before, we had no interruptions due to major incidents forcing a loss of rent. 

Expenses Paid

No matter how much rent you collect, your rental property is only as good as its actual cash flow (after expenses).

We still had a mortgage on the property, so you’ll be able to see the principal and interest paid below. HOA dues are relatively high because it’s a townhome and the dues cover the outside maintenance and the roof.

As a reminder, we purchased/built this townhome new in 2007 (it was our first home), so maintenance has historically been very low.

We pay our own property taxes directly at the end of the year and stash these savings in a high-interest savings account.

  1. $10,108.44 Mortgage Payments for 12 Months
  2. 6,891.72 Property Taxes for 2019 (down $442 from 2018)
  3. 2,520.00 HOA Dues for 12 Months (up $420 from 2018)
  4. 865.00 Insurance (Statefarm Condo Policy)
  5. $14.00 Christmas Gift for Tenant
  6. 0.00 Repairs & Maintenance!

Total Expenses Paid $20,399.16

You can see one of the downsides of owning a townhome rental property above, as our HOA raised the fee by $420.

Beyond the HOA increase, our expenses were low. Insurance premiums went down a bit, property taxes dropped, and we didn’t have a single repair.

Total Cash Flow or Net Operating Income = $6,000.84

As a result of record rents collected and one of our lowest years for expenses on record, we hit our highest recorded cash flow in the history of the property. $6,000 in cash flow! 

Here’s our cash flow/net operating income through the years:

  • 2019: $6,000.84
  • 2018: $4,318.35
  • 2017: $5,929.24
  • 2016: $1,933.72
  • 2015: $3,158.47
  • 2014: $2,104.44
  • 2013: $4,256.41
  • 2012: $(53.93)

What’s Next for Our Rental Property?

So far we haven’t had any ill-effects from the COVID-19 crisis. 

There are two big things I expect to deal with next:

  1. Renewing the lease. Our current tenant’s lease is expiring soon. Therefore, we will have to draw up a new lease renewal agreement. I will likely add an additional $25 (the minimum increase) to the rent.
  2. Paying off the mortgage. We recently paid off the mortgage, which will have a massive effect on our future cash flow.

Otherwise, I’ll continue to invest some additional cash into PeerStreet, a crowdfunding platform you can read more about in my full review.

Looking for your first rental property? 

Check out our How to Find Rental Properties guide or start your property search with our turn-key rental properties partner Roofstock.

Do you have a rental property? If so, how did yours do this year? If not, have you ever considered it? Do my results give you confidence or pause?

Photo by Isaac Smith on Unsplash

To see previous year’s click show

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About Philip Taylor, CPA

Philip Taylor, aka "PT", is a CPA, blogger, podcaster, husband, and father of three. PT is also the founder and CEO of the personal finance industry conference and trade show, FinCon.

He created Part-Time Money® back in 2007 to share his advice on money, hold himself accountable (while paying off over $75k in debt), and to meet others passionate about moving toward financial independence.

Comments

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  1. Great post! Definitely got me thinking about making an investment in a rental property. A little extra cash flow could never hurt!

  2. Great post Phil, you’ve done well here! I hope it has even helped you further with regard to Uncle Sams part. That’s the often over-looked benefit of real estate investing, oh and the increase in appreciation. Great post!

  3. GreenDollarBills.com says

    Hi Phil,
    Apologies if you’ve covered this in the past but what’s your gross/net yield on your rentals? I’m looking at arranging my own (here in London,UK) but it’s starting to look like a hell of a lot more effort than it’s worth….stock market returns look higher and with less admin!

    • Philip Taylor says

      I just have the one property. So, what you see above is it. We originally put down 41k as a down payment on this property. So, the $5,929 we made in cash flow this year represents a 14% annual return on that money. What I like about having real estate is the diversity it gives me from the market. A REIT could provide a similar feeling without as much risk. I also use a site called Peerstreet to invest this way.

  4. Jason Cabler says

    I paid cash for a rental property through my self directed IRA almost 5 years ago, and it’s been awesome! I have a property manager who takes care of everything so I literally spend only 2-3 hours a year dealing with it. I wish I had 10 more!

    I’ve had the same tenant since the beginning and repairs are usually minimal, so the cashflow is excellent! I’m reinvesting the rent money in stocks and mutual funds to juice returns and eventually build up enough for the next property.

    I wrote a series of posts on my adventures with buying my first property which you can find here: https://www.cfinancialfreedom.com/series-investing-rental-house/

  5. David Domzalski says

    Hey PT,

    I love this post. My wife and I used to be real estate agents, my in-laws own rentals, and we want to buy our first rental in 1 to 2 years. So, I appreciate your analysis.

    To answer your question, I’d go with the refi and get another property. I’d go for that over the stock market. Is this your only rental? Which way are you leaning — rental, debt payments or stocks?

    Thanks for sharing,

    Dave

    • Philip Taylor says

      Hi David, thanks for commenting. Yes, this is our one and only. We’d like another at some point but don’t have the time to find something. I’m leaning towards transferring the debt over to the personal mortgage advanced payment as it’s the easiest, no-brainer move (once we have the cash out).

  6. Thanks PT for the mention!

    People look at ROI but often forget about ROE (return on equity). Like in your situation, you can have an amazing ROI but a terrible ROE.

    For a personal residence, I completely understand the idea of paying it down to live debt free. But, for a rental property or other investment, I believe it’s best to make equity work for you to maximize your returns.

  7. Hey PT – great article, and good job with your record keeping on your rental. With regard to pulling cash out versus repaying the mortgage, that just depends on your goal for this portion of your investments – because although you have wealth “tied up” in this home it’s still that – wealth, and it increases with every dollar you amortize on the mortgage principal. Also, the 50% appreciation you’ve had isn’t too shabby either. Keep up the good work, and thanks for sharing your thoughts with us.

  8. Joseph Hogue says

    To be cash flow positive with some major expenses is a big win for rental real estate, especially to be cash flowing for several years in a row.

    I’d say go with the cash out refi but don’t feel like you need to take out all your equity. Only take out enough to the point that your payments will bring you to around cash flow balance but not negative (on a three-year average accounting for expenses). Apply the cash out to anything high interest and investments. If you’re considering adding more properties, make sure you have the time (and sanity) to manage the additional work. With so much of your wealth in property, maybe it would be better to diversify into more passive investments.

    Great post, love following these.

    • Philip Taylor says

      Thanks for the encouragement, Joseph. We definitely look at this whole project as a win. Heck, it’s allowed me to create some fun content for this blog too.

      Good conservative advice on the refi. About $30-40k is about all I could stomach. That would bring the equity down to $140k. With a $4k cash flow expected in ’17, we’d be looking at closer to ~3.0% return for this property.

  9. Great post Philip, thanks for sharing this, great read.

  10. DaveyPockets says

    Man congrats! Just started year one of a real estate business myself and it is so cool to see you cash flowing! Don’t forget to factor in home office deductions, mileage on your car, half of on your meals, and depreciation and you return is much higher than 10%!!

  11. Philip — Those are good numbers!
    I have learned maybe the best investment is by getting a quality tenant, and it sounds like you did!
    — Phillip H.

  12. Philip Taylor says

    JD in Boerne This is a great question and one I intend to answer in detail when I file my taxes this year. Rental property gives you the added benefit of being able to subtract depreciation from the income. So my $4k profit will be more like a $2k loss for tax purposes once I subtract $6k in annual depreciation expense. The loss will help reduce my overall tax burden. It’s a huge win.

    • Congrats in a profitable rental property. For the purpose of income taxes, can you categorize mortgage payments as an expense?

      • Philip Taylor says

        Thanks, James. You can categorize the interest, insurance, and property tax portions of the mortgage payment as expense. But not the principal. Schedule E is where it all goes.

  13. JD in Boerne Your taxes are never more than what you earn. Assuming you have a 25% tax rate, if your net income on the rental property is $5,000 for the year, you would pay $1,250 in taxes and keep $3,750 in after-tax profit.

  14. JD in Boerne says

    How does the rent you receive impact your taxable income? I understand that your expenses can be deducted, such as repairs and taxes on the property, but doesn’t the rent collected increase your income and essentially cost you money as you pay taxes on that income?

  15. Philip Taylor says

    DenverEric I hope so too, Eric. My first year wasn’t as good because I took a while to onboard the tenant. But I’m glad I took my time with that because it made year 2 (and beyond hopefully) really solid.

  16. I am about to rent out my Denver condo for the first time. I hope I end up with the same positive cash flow at the end of 2014 that you did for 2013!

  17. moneystepper says

    Pretty good looking figures there – 10.2% return is certainly impressive

  18. Does your mortgage include principal payments? or is it an interest only?
     
    If it is a fully amortized loan then you are probably asset positive

    • Philip Taylor says

      @MJTM It’s a standard 30 year fixed loan. So you take the principal payments out of your cash flow analysis?

      • @Philip Taylor  @MJTM Probably best to leave principal in as it’s more conservative and can’t easily be extracted.

  19. Pennysaver Pam says

    I think investing in rental property is a wise decision.  And it looks like it won’t take long until it is profitable for you. My husband and I would love to rent out property in the future as well as we think it’s a good way to diversify our investments, instead of having everything in mutual funds, etc.  Glad things are working out for you so far.

  20. @ptmoney Is that your first one? How have you enjoyed it so far? Does it make you more/less interested in doing more?

  21. This is great Phil:-)  I will pass it onto my son who has a basement suite rented out…..
    I’m sure he will find it interesting

  22. HullFinancial says

    Personally, I aim to have a little more cash flow in my properties, as the insurance will drag you down a little further and you’ll probably continue to have some maintenance costs. Still, if you can be pretty close to CF breakeven pre-tax, then you’ll wind up in the good when it’s all said and done, since you’re not having to bump into the standard deduction for mortgage interest given that it’s a rental. It’s a heck of a lot better than selling for a loss. If you can hold onto it (and keep it rented out) long enough, then you’ll either a) pay off the mortgage and have nice positive CF, or get back to at least breakeven on the capital gain of the sale.
     
    A potential topic to cover, if you haven’t already, would be the depreciation recapture rules on the sale of a rental property. A lot of people aren’t aware of it and certainly don’t understand it.

    • Philip Taylor says

      @HullFinancial What have you found is your vacancy rate across your properties? Obviously I was affected by the 1.5 months (effectively 3 months if you extrapolate) vacancy. I’m hoping to improve upon that in 2013 and see a nice positive cash flow.
       
      Now don’t go giving me work to do. I studied those rules once, but you know I’ve since forgotten them. Seriously, thanks for the push.

      • HullFinancial says

        @Philip Taylor On the Virginia property, our vacancy is 14%. We refused to let pets and opened it up in the late fall, when few people were looking to rent – or, at least, few people without pets. In our Texas properties, the rate is a touch below 8%. We have a great property manager who keeps them filled, and a great working relationship with her where she birddogs properties for us and has renters lined up as soon as we can close on the property and get it into move-in condition.