I remember the first advice that I ever received on investing in rental property. My wife and I had purchased a home and been living in it for about a year. We were ready to move and I was considering keeping the house as a rental property. So, I asked our realtor how I would know if the property would be a good rental home. Her response was typical.
She said, “If you can put 20% down on the purchase and the interest rate on the loan is 9% (mid 1980’s), then you should be able to cash flow approximately $100 per month. That would be a really good rental property.” However, she didn’t tell me that since I was moving, I would need to pay a 10% monthly management fee. Ultimately there would be no positive cash flow.
Having positive cash flow is the most important part of building wealth with real estate. What is positive cash flow? The equation below will be a life-saving tool for you if you decide to invest in real estate.
Positive Cash Flow = Monthly Rent – Principle and Interest – Taxes and Insurance
This is the formula to start with in any real estate investment consideration. So, what should your Positive Cash Flow number be? I think it is important to get a 1.5% gross monthly return on the full acquisition and rehab of the property.
This means that if I buy a property for $100,0000, spend $15,000 on rehab, I now have $115,000 invested. A 1.5% gross monthly return would be $1,150 per month in rental income. Depending on your location, a $100,000 single-family properties may be renting for $750-$800 per month so 1.5% seems too high. In that case, you may have to focus on multi-unit properties to get close to a 1.5% return.
In other parts of the country, a median rental single-family property will cost $250,000-$300,000. Some areas are even higher. In these instances, the rental fee must be higher to reflect the true value of the properties.
The Most Important Question to Ask Yourself
Keeping in mind the equation shared above, there is an important question you will need to continually ask yourself as you grow your rental property business. If you run your investment business based on Positive Cash Flow, it is crucial to understand that what a rental property costs is not what is important.
Wait, you might be saying. The cost of the property is crucial!
Remember the formula. The most important part of any rental property investment is what the property will rent for. As you invest more and more, you should be able to tell within 5 minutes if a property will be a good investment. Why? Because you’ll be asking the first and most important question that should be asked about any property, including the one you will live in as your personal home: How much will the property rent for?
Make every effort to earn a 1.5% gross monthly return. Consider the cost of the property, the principle and interest, as well as taxes and insurance. Then, determine how much you would be able to charge in monthly rent. After plugging these numbers into the formula, will you earn a positive cash flow of at least 1.5%?
I know this is difficult. It will take hard work. It may take saying no to several properties before you’re able to say yes. But I promise that asking this one most important question will ensure a successful real estate investing business for the rest of your life.
Are you interested in learning more about real estate investing? Come to my Real Estate Mastery workshop on October 19-21. You can find out more about the weekend here.
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