How to Calculate Potential Rental Income and Cash Flow
Calculating the potential rental income and cash flow of a rental property is an essential step in determining if a property is a good investment. By following a few simple steps, you can estimate the annual rental income, operating expenses, and cash flow for a property before making a purchase decision. In this article, we will break down these steps in detail to help you understand how to calculate potential rental income and cash flow for your next investment property.
First, you will need determine the market rental rate for the property. This can be accomplished in many different ways:
• You can use online rental listings like Rentometer, Zillow, or Apartments.com
• Consult with local property managers to geta batter understanding of the local rental market and what rental rates are typical for the area
• Contact local real estate agents who specialize in rental properties
• Reach out to local landlords, property owners, or investors to get their perspective
By utilizing these resources, investors can gather information on their respective market and determine their potential rental income.
Second, you need to estimate your annual rental income. Multiply the market rental rate by the number of units and the number of months in a year. For example, let’s say I am evaluating a property that has 4 units and the market rental rate is $1400/month. My annual rental income would be $67,200 (4 units * $1400/mo. * 12 months).
Third, we can calculate our Gross Potential Income (GPI). GPI is the estimated annual rental income minus, any vacancies or lost ren. It is important to take vacancies and lost rent into consideration when evaluating your deals. Each deal is unique and it is important you understand vacancy rates and rental market trends in your area, however, 5-10% vacancy is a common rule of thumb in the industry. In this example, we will estimate on the higher end of vacancy at 10%, $6,720 (Annual rental income of $67,200 * .1). Our GPI is $60,480 ($67,200-$6,720).
Fourth, we need to determine operating expenses for our property. Here are the most common operating expenses:
1. Property taxes: This is a recurring expense that can vary depending on the location and value of the property. It is calculated by taking the most recent assessed value of the property multiplied by the tax rate in the area. Your assessed value can be updated once per year and is typically 80-90% of the market value of the property. You can find an estimation of your property taxes using online tools such as Zillow or Realtor.com. This typically ranges from 2-5% of GPI.
2. Insurance: This expense can include property insurance, liability insurance, and other types of insurance that may be required for the property. To quantify this expense, investors can obtain quotes from insurance providers and factor in the deductible and coverage limits. This is typically 1-2% of GPI.
3. Utilities: This expense can include water, electricity, gas, and other utilities that the landlord may be responsible for paying. To measure this expense, investors can research the average utility costs for similar properties in the area or contact the utility providers for estimates. Insurance typically ranges from 8-12% of GPI.
4. Repairs and maintenance: This expense can include routine maintenance, repairs, and unexpected repairs that may be necessary for the property. To quantify this expense, investors can estimate the annual maintenance and repair costs based on the age and condition of the property. Repairs and maintenance is typically budgeted for 8-12% of GPI.
5. Property management: If the landlord chooses to hire a property manager, this expense can include the property manager's fees, advertising costs, and other related expenses. To quantify this expense, investors can obtain quotes from property management companies or research typical fees in the area. Property management typically ranges from 8-12% of GPI.
It's important to note that these are just rough estimates and actual expenses can vary based on factors such as property location, size, age, and condition. It's recommended to do a more detailed analysis of expenses for each specific property before making investment decisions. Also, some expenses such as capital expenditures (large, one-time expenses for items such as roof replacement or major renovations) are not included in these estimates, but should still be considered when evaluating the overall profitability of a rental property investment.
Investors typically look for all operating expenses to range between 35-45% of GPI. I assume all estimations at a higher range in order to evaluate the quality of each investment property. Using the common percentages of GPI above, our estimated annual operating expenses are as follows:
Property Taxes: $ 3,024 (5% of GPI)
Insurance: $ 1,210 (2% of GPI)
Utilities: $ 7,258 (12% of GPI)
Repairs and Maintenance: $ 7,258 (12% of GPI)
Property Management: $ 8,467 ( 14% of GPI)
Total Estimated Expenses: $ 27,216 (45% of GPI)
Fifth, we can calculate the Net Operating Income (NOI) by subtracting the GPI by the total operating expenses. This totals out to be $33,264 ($60,480-$27,216).
Lastly, we can calculate the cash flow by subtracting the mortgage from the NOI to determine the monthly cash flow. Let’s assume the debt obligation for principal + interest is $2,500 per month. The total cash flow would by $3,264 or $272/month.
Estimated Net Operating Income (NOI): $ 33,264.00
Estimated Debt Obligation: $ 30,000.00
Estimated Total Cash Flow: $ 3,264.00
Cap Rate: 8.32%
In conclusion, calculating the potential rental income and cash flow of an investment property is a critical step in determining whether a property is a good investment. By estimating the rental income, deducting vacancies and lost rent, and subtracting operating expenses, investors can arrive at an estimate of the property's net cash flow. This figure is essential for evaluating the potential profitability of the investment and making informed investment decisions.
However, it's important to note that these calculations are just estimates, and actual expenses and rental income can vary based on various factors. Investors should conduct thorough due diligence, research local market conditions, and seek the advice of professionals such as real estate agents, property managers, and accountants before making any investment decisions. By taking the time to conduct proper research and analysis, investors can increase their chances of success and achieve their financial goals through rental property investments.
