DEFINING CASH FLOW IN REAL ESTATE
While investing in real estate can be lucrative, 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, including mortgage payments, property taxes, insurance, maintenance costs, utilities, and property management fees. Cash flow is 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 residents, 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 inflation and housing demand. Property owners can also create forced appreciation by making improvements to the property. When the property is eventually sold, the owner can 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.
Real estate investors prefer positive cash flow because they profit from their properties. However, the first step in making your real estate investment profitable is understanding the basics of cash flow. Understanding cash flow is crucial if you aim to build wealth and diversify your investment portfolio. [1]
HOW DO YOU EVALUATE CASH FLOW ON A PROPERTY?
Evaluating cash flow on a real estate property is essential for investors to assess an investment’s financial performance and potential profitability.
NET CASH FLOW
To determine cash flow, you must first calculate the net operating income (NOI), the total income generated from the property minus the total operating expenses. This equation includes rental income, additional income from amenities or services, and subtracts expenses like property taxes, insurance, maintenance, advertising, utilities, and management fees. [1]
Investors then subtract any debt service payments, such as mortgage principal and interest, from the NOI. 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, maintain, and cover debt service, resulting in additional income for the investor after expenses. Conversely, a negative cash flow occurs when the property expenses and debt exceed the income, resulting in a loss for the investor.
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 should be enough to cover expenses and provide a reasonable return on investment. The surplus can either 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 or capitalization rate, which is the property’s net operating income (NOI) ratio to its current market value. A higher cap rate indicates a higher potential return on investment, but other factors, such as appreciation, vacancy rates, and maintenance costs, must also be considered.
While the average net cash flow on a rental property is 7 to 8%, it can vary widely. 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. However, investors may have different thresholds for what constitutes a good cash flow. Some prioritize steady, moderate cash flow, while others 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 of at least 1% of its 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.
This rule aims to ensure that the rent will be greater than—or at least 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 apply to all markets or situations. Investors may adjust the rule based on 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 analyses 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. The IRS (Internal Revenue Service) considers cash flow from rental property taxable income, so it must be reported to the appropriate tax authorities.
Renting out property generates passive income, which is subject to federal, state, and local taxation.
This means that investors must factor in the taxes they will have to pay on that income when performing cash flow calculations. Net rental income is generally taxed at your ordinary income tax rate. 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, 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 essential 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.
CONSISTENT CASH FLOW FOR ACCREDITED INVESTORS: MULTIFAMILY PRIVATE PLACEMENT (SYNDICATION)
By evaluating cash flow effectively, investors can make informed decisions that bring them closer to financial freedom.
For accredited investors, one investment strategy is known for its strong and consistent cash flow. It’s called multifamily private placement (syndication) investing, and it offers many of the benefits of real estate ownership but with historically fewer drawbacks.
Real estate investing is generally considered safe, but accredited investors may consider multifamily private placement, also known as syndication, an even safer option.
In real estate, a syndication deal involves pooling the financial resources of multiple investors to purchase a single property. While this can be done with any property type, many investors prefer multifamily syndication for several reasons.
First, multifamily properties, such as apartment communities, are larger and have multiple units. This means they can be a good source of cash flow, as several residents are providing rental income. Unlike single-family properties, this also means they are not as heavily impacted by vacancies. [4]
Multifamily properties are also more expensive and riskier for a lone investor to acquire. Multifamily syndication makes these more significant investments more accessible to real estate investors. Learn more about multifamily syndication returns.
An owner/operator (syndicator) is the individual who assembles the syndication deal. 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 can locate the investment property and select investors to participate. [4]
The syndicator will also handle operations once the property is acquired, making this a proper passive investment in real estate. Unlike other real estate investments, you will not have to take on the responsibilities of a landlord. No need to worry about repairs, emergencies, or problematic residents.
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 do your due diligence. [4]
The profit split will be detailed in the syndication agreement or the private placement memorandum (PPM). Depending on the deal structure, profits are typically distributed monthly or quarterly.
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 can be a great alternative to independently managing an entire apartment community and handling 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 care for it themselves.
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 several years, investors should be comfortable with some illiquidity.
Due to these risks, most syndication deals are typically exclusive to accredited investors. With their investing experience and knowledge, accredited investors can assess these deals properly. They also have the net worth and income to better absorb potential losses if an investment does not perform as expected. Regular investors may not have this kind of financial safety net.
CONNECT WITH AN INSTITUTIONAL REAL ESTATE OWNER/OPERATOR
Accredited investors looking to add multifamily real estate to their portfolios should consider multifamily syndication, especially if their goal is to generate a strong cash flow.
Investors should be aware that this is a true passive investment, meaning the syndicator will make all of the decisions moving forward. If you are uncomfortable with this, then syndication deals may not be right for you.
Because of the nature of real estate syndication, working with a syndicator you trust is essential.
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. [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]
BAM Capital partners with accredited investors who want to enjoy passive income and all the other benefits of multifamily private placement. As the private equity arm of The BAM Companies, BAM Capital has been focusing on buying the most profitable assets and staying disciplined in its investment thesis. BAM Capital’s investment strategy aims to create forced appreciation while mitigating investor risk. To date, the brand has successfully managed over $1.7 billion in assets across ~9,000 apartment units. [5]
Remember that no investment is risk-free. Before making financial decisions, consult your investment advisor and schedule a call with a BAM Capital investment team member.
Disclaimer: All investments carry risk, including potential loss of capital. This content is for informational purposes only and is not financial, legal, or investment advice, nor an offer or solicitation to buy or sell any security. Consult an independent advisor for personalized guidance and contact BAM Capital for details on current offerings. BAM Capital and its representatives are not fiduciaries or investment advisors. The information provided is general and may not reflect individual financial goals. Any financial terms, projections, or forward-looking statements contained herein are hypothetical in nature and should not be interpreted as guarantees of future performance or safety. Such statements reflect BAM Capital’s opinion and are subject to market fluctuations, economic conditions, and investment risks. Past performance does not predict future results. BAM Capital and its affiliates do not guarantee the accuracy or completeness of this information. BAM Capital offers investment opportunities under Rule 506(c) of Regulation D exclusively for accredited investors as defined by the SEC. Verification of accredited investor status is required prior to participating in any investment.
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SOURCES:
[1]: SmartAsset. (2022). “How to Calculate Cash Flow in Real Estate.” https://smartasset.com/investing/cash-flow-real-estate
[2]: BiggerPockets. (2023). “Cash Flow For Rental Properties: What is Average or Good?” https://www.biggerpockets.com/blog/rental-property-cash-flow-analysis
[3]: Investopedia. (2020). “1% Rule in Real Estate: What It Is, How It Works, Examples.” https://www.investopedia.com/terms/o/one-percent-rule.asp
[4]: Multifamily Refinance. (2023). “Multifamily Syndication: The Complete Guide.” https://www.multifamilyrefinance.com/apartment-investing-blog/multifamily-syndication#important
[5]: BAM Capital. (n.d.). “Current Portfolio.” https://capital.thebamcompanies.com
