Wondering what the average cash flow on a rental property is? As a real estate owner, your goal is twofold – keep up with inflation and generate a positive return on investment (ROI). In general, there are two ways in which an owner can achieve that goal – appreciating an asset and generating positive cash flow. An owner can achieve asset appreciation either as an active contributor by renovating the property or as a passive investor by simply buying and holding investments and hoping its value increases.
The second way an owner can achieve a positive ROI is by increasing the cash flow of the asset. In today’s market, a market filled with higher interest rates, higher inflation, and fear of recession, cash flow-focused investment styles are likely more effective than one focused on appreciation.
In this article, we’ll discuss what cash flow is, what the average cash flow on a property is, and factors that impact cash flow you would want to consider.
What Is Cash Flow?
Cash flow is the cash that is generated by an investment. Whether you are investing in a single-family home or a multi-family property, if the asset has tenants that pay either monthly, the property has cash flow.
Cash flow is arguably the most essential component in investment analysis. It is what you use to pay your investors, pay your expenses, and service your debt. There are two types of cash flows – gross cash flow and net cash flow.
Gross cash flow is the cash generated by a property from its tenants before paying for expenses. Another name for this is Potential Gross Income (PGI).
Net cash flow is the cash flow after expensing operating items such as insurance, real estate taxes, and utilities. Unlike gross cash flow, net cash flow takes into account potential vacancies you might experience over the course of the year.
What Is The Average Cash Flow On A Rental Property?
Rental properties can include any type of property asset that houses a tenant and pays rent. Because rental properties consist of so many different types of investments, it is very hard to determine the average cash flow. For instance, an industrial property in Indianapolis could yield $500,000 in average cash flow whereas a small duplex in Florida wouldn’t yield more than $50,000 of cash flow.
Although it’s difficult to assess the average cash flow of a rental property due to the property’s varying construction, usage, and geography, it’s possible to determine the average ROI and cash on cash return investors look for in an investment.
The ROI of an investment is the expected return an owner anticipates receiving over the holding period of the property. Generally, the stock market has earned between 8% – 10% annually. Therefore, given the lack of liquidity, the higher barriers to enter, and the steeper learning curve, real estate typically generates a 10% – 20% average ROI.
Another type of investment analysis investors like to use is what’s called a cash-on-cash return. A cash on cash return is the annual return investors receive from their property’s cash flow. For instance, if I invest $100,000 in a property and I receive $8,000 a year, I achieved an 8% cash on cash return. Cash on cash returns differ from ROI in that ROI takes into account the eventual sale and profit of a property at the end of the investment’s holding period. Cash on cash return simply takes the annual cash flow and divides it by the investor’s investment – it does not take into account the eventual sale of the investment down the road.
Factors That Impact Cash Flow
There are many factors that can impact cash flow. These factors can include the type of property, the property’s location, the type of financing on the property, and the property’s annual expense.
The Type of Property
No two properties are the same. As you might expect, a single-tenant commercial pharmacy in New Jersey will certainly generate a different cash flow than a single-family home in California. Properties serve different purposes and are of different heights and usages. Because properties are unique – and contain different tenants – the cash flows will differ drastically.
It is no secret that within America, there are expensive neighborhoods and there are cheaper neighborhoods. And with differently priced assets and buildings comes different types of cash flow.
The average rent in NYC right now is nearly $4,000 a month, whereas the average rent in Pennsylvania is $1,000. Because of these extreme differences, rental properties in these markets will generate vastly different cash flows.
Type of Financing
Interest rates associated with property loans can also impact cash flow. If you own a $1,000,000 property with a $650,000 loan at 3.5%, your cash flow will be higher than if you owned that very same property with a 5% loan. Interest rates can have a major impact on your rental property’s cash flow. It is for that reason that two completely identical properties could be generating completely different cash flow figures.
Lastly, a property’s expenses can impact annual cash flow.
A 250,000-square-foot office will undoubtedly have higher expenses than a small multi-family. Although the annual rent will likely be different, even if they were the same, the very usage of each building will require different expense management. Because they’ll have different insurance, taxes, and electricity, the annual cash flow will be different.
Understanding the average cash flow on a rental property is an important question to ask before engaging in an investment. However, because many properties have different usages, geographies, expenses, and financings, it is very challenging to determine the average cash flow a property will generate. A better, more accurate assessment of a property’s strength is likely a return on investment calculation or cash on cash return. A typical return on investment real estate owners might expect in order to keep up with inflation and enjoy an attractive profit is somewhere in the range of 10% and 20%.