The term “cash flow” brings up images of, well, a flow of cash. And, the basic meaning isn’t too far off the mark. Overall, cash flow is defined as the amount of profit (mainly consisting of rental income) from an investment property, minus debt service payments (i.e., mortgage payments), capital expenditures for upgrades, property expenses, and vacancy/credit loss.
In other words, cash flow is the income that remains after you pay off various expenses.
There are, however, deeper meanings to this concept. Cash flow is one of the most understood tools — and sometimes, the least understood — when it comes to successful real estate investing. While you don’t have to be a trained CPA and know all of the ins and outs of cash flow, understanding the various facets of this term is helpful when it comes to buying, maintaining, and selling a real estate asset.
In the real estate investment world, there are actually different types of cash flow, including the following:
Examining these cash flow types can help provide you with the appropriate information as to the effectiveness of a particular real estate investment.
No investment conversation would be complete without tax talk, and discussing cash flow in the context of real estate isn’t much different. Specifically, the conversation should focus on pre-tax cash flow versus after-cash tax flow.
The great thing about cash flow is that it tells you a great deal about a property, especially during the due diligence period. Cash flow analysis delves into all kinds of issues, ranging from capital expenditure (or lack thereof) on an asset, to breakeven occupancy ratios, to tenant risk assessments. The latter, with its focus on credit quality and past payment history, can tell you if your tenants are capable of continuing to pay you rent.
From an investor standpoint, your real estate’s cash flow is important. It represents a source of income, while protecting your asset(s) through capital expenditure, maintenance, and upgrades. As such, an understanding of this concept is essential to your pursuit of the best ongoing performance and value from your property investment.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.