Asking the question, “Will the monthly cash flow be positive?” is vital. I’ve seen too many investors ignore cash flow analysis in recent years. They’ve watched others recklessly purchase properties at prices that lose monthly cash flow and depend on appreciation for an exit strategy. Don’t be a sheep, use common sense and stick to your plan. When values dipped as they did recently, investors were left holding a property that was hemorrhaging cash. This is not only a terrible rental property strategy, but one that can force you to short-sell and ruin your credit. Once your credit is shot, don’t expect to receive great loans and rates again.
If you are responsible enough to analyze cash flow, be sure to follow up with “What monthly expenses can I realistically expect?” The way to do this is to take any expense you expect over the year i.e. taxes, repairs, roof replacement, etc. and divide the number by 12. For example, I expect to spend about $300/yr ($25/month) to repaint rooms when a tenant leaves. I may not incur this cost each year if a tenant renews, but I know from my monthly cash flow calculation that I’ll have enough cash built-up to cover this once-a-year expense. Don’t short-change other factors as well including annual increases in HOA dues, real estate taxes, vacancy, etc. If you think it will take 30 days to find a new tenant each year, factor in at least 8% vacancy. If you don’t know what expenses to expect, start by asking your agent and home inspector.
Lastly, don’t try to grow too quickly. I read every rental book out there for a year before buying my first property and I still made mistakes. As a general rule of thumb, I tell investors who are starting off to keep a cash pile equal to at least 6 months worth of expenses. Keep a dedicated bank checking account for your rental property. That’s where you’ll put your cash pile and where your mortgage payments can be deducted. It will give you peace of mind knowing you don’t have to constantly check your bank account to see if there’s enough cash to cover the first months.
