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## Real Estate Investing for Cash Flow

So how do you calculate positive cash flow on a real estate investment? Are you saying cash flow is the difference between your monthly rent and your mortgage payment? If so, shame on you.

In addition to the mortgage payment, there are several costs associated with managing a rental property. Most banks use 75% of the monthly rent amount as a guideline for what they think is a better indicator of what you’ll actually end up bringing. For example, if the monthly rent is $1,000 per month, they will say you have $750 per month.

So where does that other 25% go? Well, it’s the maintenance, vacancy, management, tax, insurance, legal, accounting and other costs you’d incur running a business – and don’t be fooled; real estate investing IS a business.

There is a calculation that is often used in commercial real estate investing that a few of us have adapted to the world of residential real estate investing: net operating income.

The included net business income calculations determine what the real income from the property is (excluding mortgage payments).

So if you had $1,000 a month in rental income and subtracted taxes, insurance, a reasonable estimate of the impact of vacancies, maintenance and management, the number you’re left with is your net operating income for that property.

By calculating this number first, we can use a financial calculator to determine how much debt the property can support with this monthly payment and the interest rate we can borrow at.

If the amount we can borrow is greater than the purchase price (minus whatever we are willing to use as a down payment), then we can frankly say that the property has a positive cash flow. If it’s less than the purchase price, then we know we need to invest more money or we have negative cash flow, which I think is really like paying a down payment over time.

So, the next time you’re analyzing an investment property, I encourage you to do your own net operating profit calculation to determine the cash flow of a potential real estate deal.

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