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Determining Rental Price & Cash Flow

Published on Monday - June 23, 2014

Owning a rental property can be one of the most profitable strategies you enlist as a real estate investor. The idea of having tenants pay down your mortgage, while still making money every month, is a very appealing thought. As good as the theory is, the execution can be another story. Many landlords have found out that being a landlord is hard work. Between finding tenants, taking care of the property and collecting rent, it can be a full time job. The key to having a good rental portfolio is by finding good tenants. Finding good tenants, therefore, comes down to finding the right rental amount.

The goal for most landlords is to make as much money as they can every month. Like most anything else, the real estate market is largely affected by supply and demand. Currently, we are in a period of high demand for rental property. The buying market has still not taken off as some expected, leaving many would be buyers looking to rent for the foreseeable future. Being able to charge top dollar for rent is nice, but it certainly won’t last forever.

The most important thing any landlord can do is to protect their investment. They do this by making sure the house is occupied at all times and the rent is coming in. If you charge too much, you increase your chances of the rent being late or not come in at all. A higher rent means less demand, and less prospective renters to choose from. If you are chasing the dollar instead of finding good tenants, eventually you will run into trouble. When that happens, you will lose more than just the couple of bucks you tried to get in rent.

Finding the sweet spot to charge for rent starts with looking at comparable properties in the area. A common mistake that landlords make is looking at their current rent and thinking that it has to stay the same. Rents are fluid and can change every month. If you are locked into an amount, it may not be realistic. You can overprice your market and be forced to scramble the closer you get to your lease date. It is always cheaper and easier to try to work with your existing tenant to see if they want to stay. A slight reduction of $50 a month may not seem like a lot of money, but it may be all some tenants need to stay. The alternative is to spend money and time advertising and hoping you get a tenant as good as what you have now. Sometimes by taking a little less, either with a new or existing tenant, you are really making out much better in the long run.

The cost of an eviction is never worth trying to squeeze a few more dollars out of your rental market. If you out price your market you will find that you will bypass many quality tenants that have a better chance of paying on time every month. Maximizing cash flow is important, but it is not the most important thing for a landlord. Keeping your property occupied is.

Generating income from cash flow on your rental properties can be a wonderful thing. In addition to cash flow, you may also be able to pay down any mortgages and generate equity. While this is great in theory, if you are not calculating all of the numbers and expenses properly, you will end up behind the eight ball every month or at the end of the year.

The math behind calculating cash flow is easy enough that most elementary school kids could figure it out. You take your total income and subtract it by your expenses. What you are left with is the cash flow. Determining the income part of the equation is easy enough if you are receiving rent checks every month. What most investors neglect is that even the best tenants will not guarantee timely payment. Things happen with tenants from time to time causing them to suddenly stop paying. If the income stops coming in, you will be forced to dip into your reserve fund to deal with the situation. If you do not have reserves lined up, the best plans and cash flow equations will quickly be for naught. That being said, it is critical that you take some portion of your income and allocate that to a reserve fund. If you take even 10% of every rent, you are now left with 90% of the income and have a new calculation.

Once you have your net income number you can move on to the expenses. When looking at the expenses it is important to include every single one. The principal, interest, taxes and insurance are the basic ones but it goes way beyond that. There are seasonal bills for water & sewer, lawn care, snow removal, utilities, repairs, maintenance, gas, garbage removal and more. Some of these items may be small but when added together they can be as much as 20% of your monthly rent. You may not realize them because they are spread out over the course of the year but they are still expenses and will impact your bottom line. Also, you will need reserves not only for vacancy insurance but to guard against the unexpected broken appliance or a myriad of other things that always pop up with rental properties.

If your goal is to build a long term rental portfolio, you can live with making less cash flow every month while keeping an eye on the future. If you bought the property with visions of making hundreds of dollars every month without properly adding up all of the expenses, you could be in for quite a shock. It is always best to take the conservative approach with your numbers. If you have a surplus left over at the end of the year, it should be considered a bonus. There are many good rental property spreadsheets available online or you can develop one that works for you and your market. If you don’t know all of your expenses, your rental property bottom line will definitely be impacted.

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