As an owner of several rental properties, I strongly believe that your rental property has to generate positive cash flow. Depending on where you are located, finding a positive cash flow rental property might be harder in certain areas. For example, I live in the Washington DC suburb and it is difficult to find good cash flow here; however, if you are like me and don’t want to buy a rental property that is too far from where you live, you will have to find a decent one near you — they are out there, just not easy to find.
How to Find Positive Cash Flow
For me, I have to search about an hour south of where we live. I think owning a rental property within an hour drive is not a bad compromise if you want to stay local. There are advantages of being a local landlord versus an out-of-town/state one, namely, you might be able to save money on property management, it is cheaper for you to make a trip to the property, and you can build up a portfolio of local real estate related professionals that could save you money in the long run.
1. Look for a Suitable Property
Since there are no affordable small multi-family property in my area (except in Washington DC itself which has rental laws that heavily favor tenants), I opt to focus my search on townhouses. In my opinion, townhouses make a better rental property than
- Condos, which appreciate more slowly and generally has a high condo fee or
- Single family home, which has more maintenance items and are more expensive to turnover after each tenant.
I try to target 3 bedrooms townhouses which I feel is the easiest to rent out. I generally look for mid-grade homes that are in the lower-mid level price range, as opposed to trying to find an upgraded home and has to compete with buyers that want to live in the house themselves.
As a Realtor, I am able to search the MLS so the process is a little bit easier. You can either ask a Realtor with rental properties experience to help you, or you can search on your own. I target one area at a time, search for properties that meet my search criteria, sort the result by price (lowest to highest), then I look for properties that are in decent shape and in a neighborhood that I’d be comfortable living in myself.
2. Calculate the Monthly Holding Cost
This step is easiest with a monthly payment mortgage calculator (we have one on this site, but you can use any calculator). Take note of what the monthly payment is for each property you saved on your list.
For example, here are the numbers I entered
- $300,000 purchase price
- 20% down payment (typically what you need for an investment property)
- 30 years mortgage term
- 4.5% interest rate (interest rate is a bit higher for an investment property)
- $3,300 property tax (our tax rate is about 1.1% of the property value)
- $800 property insurance
The monthly payment is $1,558 according to the calculator, plus there is a $75 a month HOA fee for a total holding cost of $1,628 per month.
3. Calculate the Monthly Rent
Next, look for similar properties for rent (in term of size, number of bedrooms, number of bathrooms, etc.) in the neighborhood and take note of the price range. For the neighborhood I am targeting, the rental rate for a $300,000 is about $1,700 to $1,900. For this example, I will assume we can rent out the house at $1,800 a month.
4. Calculate the Cash Flow
Now you take the two numbers and calculate the cash flow:
Cash Flow = Monthly Rent – Monthly Holding Cost
Cash Flow = $1,800 – $1,628 = $172
I have to tell you that $172 is not much at all, and many seasoned investors would rather go out of state where they can find much higher cash flow.
At $172 a month, you will most likely lose a little bit of money each year after you factor in all the expenses you incur as a landlord, delinquencies, and vacancies (i.e., the days when there is no tenant paying you rent).
The One Percent Rule
If you read enough about real estate investing, you are bound to come across the 1% Rule which basically say that a good rental property should rent for at least 1% of the sales price. For example, this rule said our rental property should rent for at least $3,000. In other words, our 0.6% rental property is a bad investment (i.e., $1800 / $300,000 = 0.6%).
However, as I mentioned at the beginning, the One Percent Rule is highly dependent on your location. It is damn near impossible in my area.
Cash flow is one of the most important consideration when evaluating a rental property, however, it is not the only factor. You don’t need a property that meets the One Percent Rule to make real estate investing worthwhile. In fact, I feel that you just need enough cash flow to make sure you can be a landlord without it costing you money in the short-term, because real estate investing helps you build wealth in other ways as well. My best rental property has clocked in a 25.5% annual rate of return for the past 7 years and it is barely cash flow positive, and my worst one is at 12% annual rate of return with negative average yearly cash flow. In my book, neither ones are bad investments when compared to the S&P 500 annual rate of return of around 9%.
Pinyo Bhulipongsanon is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.
Hey Pinyo! great post, this is a very helpful post, my worst one is at 12% annual rate of return with negative average yearly cash flow.