1. Cash Flow
First and foremost, if you are looking for a steady monthly income, residential income properties are one of the best investments out there. Residential real estate typically beats other types of investments, including savings accounts, certificates of deposit, the stock market, bonds, Treasuries, gold and currency trading.
The main factor to look at for maximizing your cash flow involves your total initial investment. This includes: down payment, closing costs and initial fix up costs. The more you put down, the less your monthly cost are going to be, mostly in terms of your monthly mortgage payments.
Cash Flow Formula
Cash Flow = Operating Expenses – Vacancy – Mortgage Payment
(typically expressed as a monthly figure)
Operating Costs include such things as taxes, insurance, HOA, gardening, water, maintenance, etc. They do not include mortgage payments.
Vacancy is a dollar figure calculated from the loss of income between the time former tenants move out and new tenants move in. You can calculate it yourself for your properties from experience, or use area averages. Typically, vacancy rates are about 5% of the gross income, which equates to a property being vacant for about 3 weeks a year. That’s the starting figure we use for our calculations.
Here’s an example:
|Net Cash Flow||$862|
(Click here for the SMART Glossary)
As a landlord, you can control or influence all of these numbers to your advantage, some more than others. For instance, you can raise rents, but may or may not get them, depending on the rental marketplace. Or, you can try to keep your costs down, but you do not want to let a property deteriorate so that it is unattractive for prospective renters to live there.
This is great, but remember that putting down larger amounts, like 50% or all cash, will affect your Return on Investment. See our section on “Leveraging“.
And with condos, don’t forget the monthly HOA fees eating into your cash flow.
Bottom line: you need a complete & accurate calculator to determine the right mix of initial investment, purchase price, cash flow & ROI for your investment needs. We happen to have such a tool: our SMART Return on Investment Analyzer©. Check it out and see how well it works for you.
Over time, real estate investing is the best way to watch your money grow, and the rewards far outweigh the risks. Nothing is certain, of course, but here are some things to consider:
- As the economy improves, employment rates increase and housing demand follows suit
- Rental demand is showing unprecedented growth, and is expected to continue for the significant future
- Interest rates are still near historic lows, and will eventually rise, sparking a huge demand
- Waiting to get into the game will cost you in lost opportunity gains, in all of these price categories
All these factors point to rising residential income property prices in the near future. As the old saying goes: “Now is a great time to buy”. This applies to income property extremely well.
3. Principle Reduction
Mortgage Balance Down▼ – Equity Up▲
Paying off your mortgage is a great way to build equity. It’s a normal part of the lending process, and a significant contribution to the concept of leveraging your investment.
Here’s an example:
Let’s say you purchased a $700,000 fourplex, putting 25% down at a 4% interest rate. Your monthly mortgage payment (principle + interest) would be $2,506.
At the beginning, your mortgage balance is $700,000. You are paying $ a month towards principle, and $ a month towards interest.
The principle payments are very small at the beginning. The lender wants to maximize their interest collection. However, they gradually increase and the ratio changes.
In this example, by year 5, you will have reduced your principle balance down to $473,926.
Which means you have accumulated $226,075 in equity in those 5 years. If you sold the property then, that money would go into your pocket (less closing costs, etc.) Good job!
Check out our “SMART Investment Strategy That Works” video.