If you are thinking about buying some rental properties as
investments, you should probably understand how to project cash flows
and evaluate the investment returns you hope to achieve on your hard
earned invested cash equity.
There are really
two types of returns that we can earn on investment
property, first is appreciation in value which is the most common hoped
for return. Secondly, and much more important but generally overlooked
by investors, is the cash flow picture the property will generate.
The vast majority of investors buy real estate with the hope that it
will go up in value. This is really a big mistake because many
properties, particularly the prize “location, location, location”
properties have corresponding negative cash flows on operations that may
negate any true increase in wealth from one’s long term appreciation in
value.
So a savvy investor needs to look at the cash flow picture and buy
properties with positive cash flows, not negative cash flows. As an
example of this in Scottsdale, one could buy a nice condo for around $500,000 which would rent for about $2,300 per month. That rent,
minus all the maintenance
expenses, HOA fees, insurance, property taxes, and mortgage payment
would have a deficit on cash flows of about ($1,000) per month, or
($12,000) per year.
So while a buyer is hoping some appreciation in value will earn him
or her a fair rate of return, that appreciation has to additionally
compensate for all the money he has to take out of his savings to cover
the negative cash flows. Those negative cash flows, on this example,
could span several decades and hundreds of thousands of dollars before
the property turns positive.
Alternatively, there are many properties that cash flow positive from day one as an investment. A moderately
priced house, only a little ways away in the
$150,000 price range, might generate $1,300 per month in rent and
positive cash flows of $325 per month. That’s $3,900 per year of
positive cash flow. As a side note – the appreciation in value, over the
long term, will probably be similar on both properties anyhow. So why
not go for cash flow plus appreciation in value!
To calculate a cash on cash return, we divide that $3,900 positive
cash flow by the cash equity we invested, maybe $40,000 on the $150,000
property for a cash on cash investment return of 9.75% on our money. And
that’s a really good deal! Especially compared to the fancy prize
condominium that might generate a negative (8.5%) return on our invested
equity.
iDeal Realty & Management
9051 W Kelton Lane, Suite 10
Peoria, Arizona 85382
(623) 201-3544