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How to build a cash flow model for your real estate investment property

How to build a cash flow model for your real estate investment property

Are you about to start investing in real estate? Or maybe you’ve already put your toe in the water, but want to learn more. Here is an overview of the factors you should look at to project your potential return on an investment.

  • Purchase Price – Obviously, the amount of money you pay for the property is important in determining the return on your investment.
  • The annual appreciation rate at which you expect the value of the property to increase.
  • How many years you expect to keep the property. Combined with the 2 figures above, this will allow you to estimate a future selling price.
  • Number of rental units and rent you expect to receive from each unit.
  • Annual rental appreciation rate.
  • Expected Vacancy Rate – It is important to remember that tenants come and go, and will occasionally leave you with empty rental units. It’s best to plan for that in your projection.
  • Any miscellaneous income you anticipate (laundry facilities, etc.) and the rate at which you expect that income to grow.
  • Property management fees. Even if you hope to manage the property yourself, it’s best to budget for a professional property management allowance. First, this rewards you for the time and effort you invest. Second, it ensures that you are covered if, for some unforeseen reason, you need to turn the administration over to a professional at some point in the future.
  • Last but not least, you need to know your opportunity cost, something big investors would call the ‘cost of capital’. For example, if you can earn 5% by keeping your money in the bank, you’ll want much more than 5% for taking on the risk and time investments that a rental property requires.
  • Annual operating expenses and the rate at which you expect those expenses to increase during your period of ownership.
  • Property taxes and annual rate of increase.
  • Insurance and annual rate of increase. Insuring your substantial investment is critical!
  • Any miscellaneous expenses and annual rate of increase.
  • Depreciation expense. To determine this, you’ll need to estimate the appraised value of the building as a percentage of the total purchase price.
  • Your annual capital investments in the property. He was planning to budget for the capital improvements, wasn’t he?
  • Down Payment: How Much Cash Are You Putting Down Up Front?
  • Bank Fees – How many points do you expect to pay and what closing fees do you expect to incur if you put a mortgage on the property?
  • What mortgage interest rate do you expect? And how long will the recovery period be?

Now that you have all the numbers laid out in front of you, you ‘just’ need to build a financial model that allows you to project cash flow over your period of ownership, and then use time value of money calculations to create a present value of those flows. Compare the present value of your future cash receipts to the amount of cash you will be shelling out up front. If you are older, congratulations, you have a positive net present value and this property looks attractive. If the result is negative, it is a red flag: you should look again, because it may not be a good deal for you.

The obvious comment you might have is… “This all sounds terribly difficult! Aren’t there any tools that can help me?”

The good news is that there are! In fact, you can use a online investment property calculator which will do all the heavy calculation for you. Simply enter the numbers and review the results. Now THAT is a smart investment!

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