In the real estate industry, having skills in math is a must, especially when there’s profit involved. According to investment lenders, by estimating the potential cash flow, seasoned investors can tell if the multi-family rental property on the table is worth the time and money or not.
The good news is, you don’t have to be a math whiz to do it. All that’s needed are some simple equations to get a ballpark estimate of your potential profit. Once you have a better idea if the multi-family rental property you’re eyeing is worth it, that’s when you can perform your due diligence in researching and doing thorough analyses.
To help you out, here’s what you need to know about estimating the cash flow of a multi-family rental property.
Understanding the 50% Rule
One trick that expert investors use to get a quick ballpark estimate is the 50% rule. Here, always keep in mind that the expenses of a property are around half of its potential revenue.
While it’s true that in most cases the actual amount of the expenses can exceed more than half of the revenue, the rough estimate is still useful. For one, the figure will help you gauge if the property is overvalued or if it has the potential for profit. Also, you can use the number as the base for other computations.
Breaking Down the Cash Flow
To help you use the 50% rule, here’s a breakdown for cash flow in the simplest equation possible:
Total Income – Total Expenses = Cash Flow
What you’ll do is take the overall monthly rent amount as the income, then divide it in half and assume that’s your expenses. Subtract the expenses from the income and you’ll get the cash flow for that month.
So, say the real estate is a 5-unit multi-family property where each tenant pays $800 in rent each month. By following the breakdown, the overall income would be $4000, which is 800 x 5 (rent multiplied by the number of tenants). And, by applying the 50% rule, you get $2000 for the expenses (overall income divided by 2).
At this point, you can add the mortgage of the property to have a more accurate estimate of your expenses. For simplicity’s sake, say you’re paying $1,300 in investment property loans. In the end, the total amount is $3,300 (expenses + mortgage).
Using the numbers from that example, here’s what you’ll get:
$4000 (income) – $3,300 (expenses + mortgage) = Cash Flow
$700 = Cash Flow
By following the 50% rule in ballpark estimation, you’ll have $700 for your monthly cash flow, or $8,400 annually from the property.
Expenses by the Numbers
To have a more realistic cash flow, you can adjust the value of the expenses where different factors are taken into account. Aside from the mortgage, here are what you should include in the equation:
- Home Owners Association Fees
- Maintenance and Upkeep
- Capital Expenditures
- Management Expenses
For this part, since these factors can change depending on the situation, their actual figures are almost impossible to get. So, you’ll have to do your research and make a few phone calls to have a more accurate estimate of the expenses.
If you have experience in the industry and are familiar with the local market, you might already have a rough figure of some factors. But, if you’re new to this, the best thing to do is to talk with property managers, realtors, and other entrepreneurs in the business and ask for their advice. Contact Investor Loan Source to learn more about ballpark estimating and for assistance in investor real estate loans.