How to Calculate Positive Cash Flow on a Real Estate Investment

A real estate investment earns you money in two ways. Appreciation is the increase in the property's value over time, so that you can eventually sell it for more than you paid. Cash flow is income your property generates month to month. In some cases, investors expect negative cash flow -- less income than expenses -- and rely on appreciation to generate returns on their investments. More often, however, positive cash flow -- having money left from rent after you've deducted the costs of doing business -- is the goal. Calculate tax flow before and after taxes for the clearest snapshot of the wealth your investment generates.

Instructions

Operating Income

1. Find your gross scheduled operating income by adding the full year's maximum rent. If you charge $1,000 per month rent, for example, the gross operating income is $12,000.

2. Compute your loss from vacancy. If the property is vacant for one month, your loss due to vacancy is $1,000, or 4.5 percent, of the possible $12,000 maximum. Multiply .045 -- the decimal for 4.5 percent -- by $12,000 to arrive at a $540 loss due to vacancy.

3. Compute the net operating income by subtracting the vacancy loss from the gross rent. $12,000 minus $540 equals $11,460.

Operating Expenses

1. Calculate the interest on your mortgage loan. Multiply the annual interest rate by your total loan amount -- the amount you borrowed, not the amount you paid for the house. For a $140,000 loan at 10 percent interest, for example, the annual interest cost is $1,400, or 10 percent of the loan.

2. Total your other operating costs. Include maintenance and repairs, property tax, insurance premiums and other expenses associated with operating the property as a rental. Assume these to total $5,000 per year for this example.

3. Add the mortgage interest payments and other operating costs to find your gross operating expenses. The $1,400 for mortgage interest and $5,000 in other operating costs equals $6,400 in operating costs.

Depreciation

1. Deduct the value of the land from the purchase price of the property to arrive at the price of the house alone, as land doesn't depreciate. If you purchased the property for $200,000, for example, and the land is worth $50,000, subtracting it would leave you with a price of $150,000 for the house.

2. Divide the price of the house by 27.5, the number of years over which you'll spread the depreciation. A $150,000 house depreciates $5,455 per year.

3. Estimate your income tax savings from the depreciation. If you are in a 28 percent tax bracket, you save 28 percent of the $5,455 depreciation for a tax savings of $1,527.

Additional Income

1. Compute the value of capital improvements you made to the property -- improvements that increase its value. If you spent $10,000 to add a deck, your capital improvement cost is $10,000.

2. Total money you received from loans you took out on the property, such as a second mortgage to finance the capital improvement. Assume that to be the full $10,000 deck cost.

3. Add other income and credits. In this example they include $10,000 for the capital improvement, $10,000 for the loan that financed it and the $1,527 tax savings from the building depreciation. These total $21,527.

Finding Cash Flow

1. Add the additional income to the net operating income of $11,460 for a total of $32,987.

2. Subtract the total operating expenses which, in this example were $6,400, from $32,987 to arrive at $26,587 in before-tax cash flow.

3. Subtract your income and/or business tax from the before-tax cash flow to find your after-tax cash flow.

References

• Property-Investing.org: Before Tax Cash Flow
• "The Wall Street Journal"; Buying a Rental Property That Will Generate Cash; June Fletcher; December 9, 2005
• Kenneth D. Eichner, PC: How to Calculate Cash Flow from Rental Property
• Pro Apod; Cash Flow Before and After Taxes; James Kobzeff
• GoodMortgage.com: Investment Property Calculator