In my business, I have a saying: “Cash flow is king, equity is queen, and debt is a joker.” Cash flow is like the heartbeat of any business: it tells you how steady your business is running and looks best when it’s constant. But determine how healthy your cash flow is can be tricky for any real estate investor, no matter their experience. So let’s talk about how cash flow works with real estate investments to give you a better idea of what matters when it comes to your business accounting.
Cash flow in real estate investing is determined by the amount of money coming in through rent payments or property sales, balanced with the amount of money going out. In addition to the usual expenses businesses should account for, real estate investors should also factor in the costs of management, mortgage payments, vacancies, repairs, and home improvements, just to name a few.
If you’re not mathematically inclined, don’t worry because it’s not as overwhelming as you may think. Let’s talk about what cash flow is, how it’s different from profits, and what costs you should keep track of. I’ll also give you a few tips for where the money is hiding in your real estate portfolio. Let’s dive in.
What is Cash Flow?
First, before we jump further into this, I want to talk more about what “cash flow” actually means, as many new investors get it confused with profit.
Cash flow is the money that runs in and out of your business. As rents come in or as a property gets sold, your cash flow increases. When bills get paid, your cash flow decreases. Whatever is left over is considered profit once your expenses are paid from the rents and other revenue streams.
What Should I Consider an Expense for My Real Estate Investments?
So what are all of the variables you should consider when figuring out your cash flow? There are a few general ones that are relevant to most businesses like:
- Staff payroll (including your own. Please don’t forget to pay yourself!)
- Office supplies
- Utilities like phone and internet
- Corporation taxes
- Professional services (lawyers, accountants, other people smarter than you)
As real estate investors, we have a few other expenses that need to be taken into account, as well.
- Management fees (if you’re paying a third party to handle your rentals)
- Mortgage payments
- Property taxes (these are sometimes folded into your mortgage)
- Home Owner Association (HOA) fees
- Small repairs
- Contractor fees
- Capital improvements (new roof, other large purchases)
- Vacancy costs (How much does it cost you when your homes are vacant? I usually put this at about 5% of my total costs)
Many investors won’t account for the costs that come with repairs, improvements, and vacancies, which I find to be a bad idea. The more you understand all of the places your money goes, the better you’ll be able to stay afloat during lean times and remain profitable.
How Do You Make Money with Real Estate Investments?
With so many costs to account for, how can real estate investing be profitable? It just doesn’t seem possible.
The truth is, real estate investing can be highly profitable, but you need to be smart about how you handle your cash flow. Many of the expenses listed above can be offset by tax write-offs, which lowers your overall taxable income. But creating profit in real estate isn’t just finding tax write-offs. Depreciation is also a valuable tool to have in your investment accounting methods as it can help bring overall costs down.
The most profitable avenues for real estate investors are three-fold:
- Appreciation – Over time, real estate prices continue to rise. There may be dips here and there, like the Recession of 2008, but look at what property is valued at now, a decade later. While you may run into bumps here and there, your overall net worth will only increase when you have real estate investments.
- Amortization – Whenever portions of rent payments go towards paying off your mortgages, this increases your profitability. The less you owe to the bank, the more money you’ll have to play with.
- Raising Rents – Like property appreciation, rent prices continue to rise to meet the demand. The more rent you can charge, the more likely you’ll have a positive cash flow that creates profitability.
You’re probably thinking, “That all sounds great, Ryan. But how can I make money today?” The answer is: you most likely can’t. Real estate investing is a great way to increase your overall net worth, but it’s not a quick strategy for creating long-term monthly cash flow. The profits come once the equity is all yours, and that just doesn’t happen overnight for most of us. When it comes to real estate investing, you’ve got to play the long game.
That said, I don’t want you to think you need to be a property conglomerate before you can turn a profit. Many real estate investors do just fine with a single multiplex or a few single-family homes. What’s more important is that you keep your focus on streamlining your cash flow as much as possible. The sooner you can keep a reliable revenue stream coming into your business, the easier it will be to become profitable.
The Properties that Are the Most Profitable
In the end, the most profitable real estate investment is one that you can manage comfortably. While a large apartment complex has potential for lots of revenue, that doesn’t mean it’s the right property for your business. If you prefer a business model that focuses on fix & flips, don’t feel like you need to rent real estate.
One thing I do recommend, though, is that you create a business model that allows for multiple streams of income. Having a mix of strategies makes it so that one can prop up the rest of the business if the other side is down. It’s the old “don’t put your eggs in one basket.” Diversifying your income stream creates a steady foundation for your business to grow.
A few types of real estate business models:
- Rentals – Whether you’re dealing with single-family, duplexes, or multiplexes, receiving monthly rent payments ensures you have a steady revenue every month.
- Fix & Flips – If you’re looking for faster payouts and don’t want to deal with the headaches of being a landlord, flipping homes in a seller’s market like this can be very profitable.
- Wholesaling – If you’re interested in real estate investing but don’t have the best credit history, wholesaling can be a great way to get in the game.
- Hard Money Lending – Becoming a lender for real estate investors who need a bridge between what they have and what they need can be very profitable. It can also carry lots of risks, so do your research before jumping into private financing.
Turning a profit in your real estate investment business is a long-term play, but one that’s well worth the wait. The better you can set yourself up for success by paying attention to your cash flow, the higher the likelihood that you’ll start turning a profit much faster than your competitors.
Any tips I missed that you think new real estate investors should know about? Leave a comment and let us know.