Good news!!! There are lots of good deals out there. But even if a deal looks too good to resist, you need to be sure you understand the two significant elements that will determine profitability: cash flow and return on investment (ROI).
Expenses vs. Revenues
Cash flow is extremely important because it dictates whether the investment will cost you out-of-pocket money or put money back in your pocket on a monthly basis. To determine monthly cash flow, you must consider all expenses related to the property and then subtract this from the revenue being generated.
Finding the obvious expenses is pretty easy, but you may have to do some digging to uncover the not-so-obvious expenses. These line items are real and can significantly impact your monthly cash flow, so don’t leave anything out. They can include:
- Vacancy-rate impact
- Replacement equipment
- Tenant repairs
- Payment delinquencies
After you subtract all expenses from the revenue, you’ll know whether you’ll be making money or paying money.
The question is: Why would I involve myself in an investment that is going to cost me out-of-pocket money? This brings us to the next important variable when evaluating your real estate investment decision: return on investment (ROI).
What Is ROI, Anyway?
The “ROI” is the rate of return based on an initial investment that generates a cash annuity for a specified time period. Now, in plain English: ROI is basically the money going out (including your initial investment) banked against the cash flow that the property will generate in a given amount of time. This creates a net cash flow stream, and your return percent is calculated off of this figure.
When compiling these cash flows, you must include all expenses related to the property, and the revenue stream must include all monetary benefits derived from it as well. ROI is heavily determined by the initial investment, because that is most likely the largest cash outlay related to the investment. All other variables held constant within the same scenario dictate the bigger the down payment, the less return you will have on the investment.
So, the question is: If my return is less, why would I put a larger amount down? You must consider the trade-off between the amount of the down payment and the monthly cash flow. The more you put down, the more likely you are to have a positive cash flow – the investment paying you dividends. There is a fine balance between cash flow and ROI.
A great agent can help you can determine the best scenario that suits your needs and financial goals.
Whether your goal is to generate an annuity stream, prepare for retirement or create a college fund, real estate investments can be an excellent place for your money, if you do it right. With interest rates at record lows, profitable inventory and opportunities throughout the nation, it may be time for you to invest in property.
I’d love to help you find your first or your next investment property!
It’s a Great Day in Real Estate!