What Is Cash Flow in Real Estate?

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Table of Contents

Defining What Is Cash Flow In Real Estate

While investing in real estate can be a lucrative venture, understanding cash flow is essential for success.

Cash flow refers to the net income generated from a property after deducting all expenses associated with its operation and maintenance. This includes expenses such as mortgage payments, property taxes, insurance, maintenance costs, utilities, and property management fees. Cash flow is essentially the amount of money that remains after all these expenses have been paid. Simply put, cash flow is the movement of money in and out of a business. [1]

Positive Cash Flow

Positive cash flow occurs when the income generated from the property exceeds the total expenses, while negative cash flow occurs when expenses surpass the income.

There are several ways in which cash flow can be generated in real estate. The most common method is through rental income. Property owners receive rental payments from tenants, typically on a monthly basis. [1]

Forced Appreciation

Additionally, cash flow can be generated through appreciation in property value. Real estate properties tend to increase in value over time due to factors like inflation and demand for housing. Property owners can also create forced appreciation by making improvements to the property. When the property is eventually sold, the owner can realize a profit from the appreciation, thereby increasing their cash flow.

Other methods of generating cash flow in real estate include leasing out space for commercial purposes, such as retail stores or offices, and through alternative strategies like real estate investment trusts (REITs) or crowdfunding platforms.

Real estate investors prefer positive cash flow because it means they are making money on the properties they own. But the first step in making your real estate investment profitable is to understand the basics of cash flow. If your goal is to build wealth and diversify your investment portfolio, understanding cash flow is crucial. [1]

How Do You Evaluate Cash Flow on a Property?

Evaluating cash flow on a real estate property is essential for investors to assess the financial performance and potential profitability of an investment.

NOI – Net Operating Income

To determine cash flow, first you need to calculate the net operating income (NOI), which is the total income generated from the property minus the total operating expenses. This includes rental income, additional income from amenities or services, and subtracting expenses like property taxes, insurance, maintenance, advertising, utilities, and management fees. [1]

Once the NOI is calculated, investors subtract any debt service payments, such as mortgage principal and interest. The resulting figure represents the property’s net cash flow.

Positive cash flow indicates that the property generates more income than it costs to operate and maintain. It means the investor has additional income after expenses. On the other hand, negative cash flow means that the property expenses exceed the income. In this case, the investor is losing money.

Evaluating cash flow allows investors to gauge the potential return on investment (ROI), assess risk, and make informed decisions regarding real estate properties.

How Much Cash Flow Should a Rental Property Have?

Generally, investors aim for positive cash flow, which means it should be enough to cover expenses and provide a reasonable return on investment. This surplus cash can be reinvested, used to pay down debt, or serve as passive income for the property owner.

A commonly used metric to assess cash flow is the “cap rate” or capitalization rate, which is the ratio of the property’s net operating income (NOI) to its current market value. A higher cap rate indicates a higher potential return on investment, but it’s crucial to consider other factors like appreciation, vacancy rates, and maintenance costs.

While the average cash flow on a rental property is 7 to 8%, how much you actually earn will depend on the location, cost of living, amenities, rental demand, and other economic factors. [2]

Investors often aim for a cash-on-cash return of at least 8-12%, meaning that the annual cash flow should be at least 8-12% of the initial investment. Investors may have different thresholds for what a good cash flow is. Some investors prioritize steady, moderate cash flow, while others may prioritize high returns with higher risk.

What is the 1% Rule in Real Estate?

The one percent rule, sometimes stylized as the 1% rule, is a general guideline used by investors to quickly evaluate the potential profitability of a rental property. [3]

It states that a rental property should generate a monthly rental income that is at least 1% of the property’s total purchase price. For example, if a property is purchased for $200,000, it should ideally generate a monthly rental income of $2,000 or more to meet the 1% Rule.

The goal of this rule is to ensure that the rent will be greater than—or at worst equal to—the mortgage payment so the investor at least breaks even on the property. [3]

However, it’s important to note that the 1% Rule is just a guideline and may not be applicable in all markets or situations. Investors may adjust the rule based on factors such as location, property type, market conditions, and financing terms.

Additionally, while the 1% rule can help identify potentially lucrative investment opportunities at a glance, it should be used in conjunction with other financial analysis and proper due diligence. The 1% rule alone may not be enough to paint the whole picture. It is just one measurement tool that can help investors gauge the potential gain of an investment property. [3]

Do You Pay Taxes on Cash Flow from Rental Property?

The short answer is yes, rental income is subject to taxation. Cash flow from rental property is considered taxable income by the IRS (Internal Revenue Service) and must be reported to the appropriate tax authorities.

The income generated from renting out property is categorized as passive income, which is subject to taxation at the applicable federal, state, and local levels.

This means that investors need to factor in what they will have to pay in taxes on that income when performing cash flow calculations. Net rental income is generally taxed at your ordinary income tax rate. This means if you are in a higher tax bracket, you could pay more in taxes on rental income. [1]

The specific tax treatment can vary depending on the property’s location, your filing status, and any deductions or credits you may qualify for. Rental property owners can deduct certain expenses, such as mortgage interest, property taxes, and depreciation, to reduce their taxable rental income. [1]

It’s important to keep accurate records of income and expenses related to your rental property to ensure compliance with tax laws and to maximize potential deductions. Additionally, seeking guidance from a tax professional can help you navigate the complexities of rental property taxation and ensure you’re taking advantage of all available tax benefits while remaining compliant with the law.

Best Source of Consistent Cash Flow for Accredited Investors: Multifamily Syndication

By evaluating cash flow effectively, investors can make informed decisions that will bring them closer to financial freedom.

For accredited investors, there is one great investment strategy that is known for its strong and consistent cash flow. It’s called multifamily syndication investing and it gives you many of the benefits of owning real estate, but with much fewer drawbacks.

Real estate investing is generally considered safe, but accredited investors should consider multifamily syndication if they want an even safer option.

In real estate, a syndication deal is an investment that involves pooling together the financial resources of multiple investors to purchase a single real estate property. This can be done with any type of real estate, but many investors prefer multifamily syndication for several reasons.

For starters, multifamily properties like condominiums and apartment communities are larger and have multiple units. This means they are a good source of cash flow because there are several tenants providing rental income. It also means they are not heavily impacted by vacancies, unlike single family properties. [4]

Multifamily properties are also more expensive and therefore riskier to acquire for a lone investor. Multifamily syndication makes these larger investments more accessible to real estate investors. Learn more about multifamily syndication returns. 

A syndicator is the one who puts the syndication deal together. Also known as the sponsor, they take on most of the responsibilities in the syndication, from creating the business plan to executing it. As the general partner, the syndicator is the one to locate the investment property and select investors who will participate. [4]

The syndicator will also take care of property management once the property is acquired, making this a true passive investment in real estate. Unlike other real estate investments, you will not have to take on the responsibilities of a landlord. There’s no need to worry about repairs, emergencies, and problematic tenants.

The investors have limited responsibilities and liabilities in the syndication deal. They will provide most of the capital needed to acquire the property. In return, they will earn a share of the property’s cash flow, and depending on the deal structure, a share of the equity upon resale. Every syndication deal is different, so make sure you do your due diligence. [4]

The profit split will be detailed in the syndication agreement or the private placement memorandum (PPM). Profits are typically distributed on a monthly or quarterly basis, again depending on the deal structure.

Real estate investors only have to worry about their share of the capital instead of taking on the risk of an entire multifamily property. This is a great alternative to running an entire apartment community by yourself and handling all of its day-to-day requirements.

In a syndication deal, accredited investors can just sit back, relax, and enjoy the fruits of their investment while the syndicator takes care of the property. They may hire a third party property management company or take care of it themselves. Either way, investors don’t have to be concerned.

Keep in mind that even multifamily syndication deals have their risks. For example, they still require a significant amount of capital upfront, so it’s not an investment that you can take lightly. And because these deals tend to last for several years, investors should be comfortable with a bit of illiquidity.

Because of these risks, most syndication deals are exclusive to accredited investors. With their investing experience and knowledge, accredited investors have the ability to assess these deals properly. They also have the net worth and income to keep  themselves safe in case an investment does not work out. Regular investors may not have this kind of financial safety net.

Work With BAM Capital for the Best Multifamily Real Estate Syndication Deals

For accredited investors looking to add multifamily real estate to their investment portfolio, multifamily syndication is a great option, especially if your goal is to generate a strong cash flow.

Investors should be aware that this is a true passive investment, meaning it is the syndicator who will be making all of the decisions moving forward. So if this is something you are not comfortable with, then syndication deals may not be right for you.

Because of the nature of real estate syndication, it is essential to work with a syndicator you trust.

Work with BAM Capital if you want to work with a syndicator with a track record for excellence. BAM Capital is a leader in its industry, known for its award-winning investment strategy that mitigates investor risk while creating forced appreciation. In fact, BAM Capital now has over $700 million AUM and 5,000+ units.

BAM Capital is an Indianapolis-based syndicator that prioritizes high quality multifamily properties with in-place cash flow and proven upside potential, particularly those that are Class A, A-, and B++. [5]

As a vertically-integrated company, BAM Capital can also handle every step of the syndication process, from acquiring the properties to renovating and managing them. They can guide you every step of the way. [5]

No investment is without risk. Make sure to consult your investment advisor or speak to a BAM Capital investment team member before making any financial decisions.

For accredited investors who want to enjoy the passive income and all the other benefits of being in a multifamily syndication, schedule a call with BAM Capital and invest today.

Sources:

[1]: https://smartasset.com/investing/cash-flow-real-estate

[2]: https://www.biggerpockets.com/blog/rental-property-cash-flow-analysis

[3]: https://www.investopedia.com/terms/o/one-percent-rule.asp

[4]: https://multifamilyrefinance.com/apartment-investing-blog/multifamily-syndication#important

[5]: https://capital.thebamcompanies.com/