Real Estate Investors
For many Real Estate Investors , the concept of real estate investing ties strongly to price appreciation. Buy a property now, and sell it later for more money. Whether it’s a “flip” sold a month later or a building held for 25 years and sold, the approach is the buy-low, sell-high strategy you might see from a stock-market investor.
Rental-property cash flow, stock dividends and bond payments have different risks, costs and payment arrangements. Evaluate each investment on its own assumptions rather than treating one source of income as automatically superior.
One big advantage that gives the real estate investors the ability to hedge their bets. Warren Buffet, considered by many to be the world’s greatest investor, once listed his two rules of investing:
Rule No. 1 – Never lose money
Rule No. 2 – Never forget Rule No. 1
Of course, it’s impossible never to lose mone; even Buffet has had some investments that didn’t turn out so well. But one of the ways to guard against losing money on a real estate investment is to keep cash flow in mind, rather than simply trying to buy low and sell high.
A cash-flow example with operating costs
Consider a hypothetical $100,000 rental-property purchase with a $20,000 down payment, an $80,000 loan and $5,000 in cash-paid acquisition costs. Total cash invested is $25,000. The following figures are assumptions for explaining the calculation, not current market rents, a loan quote or a forecast.
- Scheduled annual rent: $13,200
- Less vacancy and collection loss allowance: $660
- Effective annual rental income: $12,540
- Less operating expenses: $4,500
- Net operating income: $12,540 − $4,500 = $8,040
- Less assumed annual debt service, including principal and interest: $4,500
- Annual pre-tax cash flow: $8,040 − $4,500 = $3,540
- Cash-on-cash return: $3,540 ÷ $25,000 × 100 = 14.16%
The assumed operating expenses include property taxes, insurance, routine repairs, management and owner-paid services. This simplified example assumes no additional capital spending or reserve contributions during the year. If either is needed, the cash available to the investor will be lower. For a full explanation, see the cash-on-cash return versus ROI guide.
Cash flow is not guaranteed
A signed lease establishes payment obligations; it does not guarantee collections or an investment return. Vacancy, missed rent, repairs, taxes, insurance, financing costs and additional cash contributions can change the result. Property value and selling costs also matter when evaluating the investment’s total outcome.
Compare projected cash flow with the property’s actual operating records and test less favorable scenarios. Higher vacancies, lower rent or major repairs can reduce cash flow or make it negative. Avoid comparing an illustrative property return with a stock-market return as though their risks, costs and time periods were equivalent.
Maybe as important is the fact that you can use cash flow for other things: paying monthly expenses, going into a college fund, or reinvesting. None of those things can be done with a property appreciation until that property is sold.
And that’s why cash flow might be a more critical number for real estate investors than price appreciation.
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