The Real Estate Cash Flow Formula (Everyone Gets This Wrong)

Summary

In this video, real estate expert Dave Meyer critiques the oversimplified and often misleading cash flow calculations shared by influencers on social media. He emphasizes the importance of accounting for all expenses—like repairs, vacancy, and property management—when calculating cash flow. Dave breaks down the process of calculating cash flow accurately and offers advice on conservative investing, including how to estimate expenses and calculate cash on cash return. By being realistic and accounting for worst-case scenarios, investors can avoid financial surprises and make smarter investment decisions in today's market.

Takeaways

• 😀 Don't trust influencers who oversimplify real estate cash flow analysis by excluding key expenses like repairs, taxes, and vacancies.
• 😀 Proper cash flow calculation is simple: Income minus expenses, but be sure to include all categories of expenses for an accurate analysis.
• 😀 Always be conservative with your expense estimates to ensure you're prepared for worst-case scenarios in your investment.
• 😀 Debt service (mortgage payment) is a predictable, fixed expense and should be included in your cash flow calculation.
• 😀 Operating expenses include repairs, maintenance, capital expenditures (CapEx), turnover costs, and vacancy. All of these should be accounted for.
• 😀 Don't forget about property management fees—even if you plan to self-manage, include them in your analysis for future flexibility.
• 😀 Assume that some things will go wrong with your property (vacancies, repairs, etc.) so that you can be prepared financially if they do.
• 😀 Cash-on-cash return in today’s market should generally fall between 3% and 6% for a good deal, with higher returns expected for riskier properties.
• 😀 Factor in real estate's other financial benefits, such as appreciation, amortization, and tax advantages, to justify the investment over safer assets.
• 😀 Use tools like Bigger Pockets calculators and Deal Machine to streamline the real estate analysis process and get more accurate estimates.

Q & A

What is the primary issue with how some influencers present real estate deals on social media?

The primary issue is that influencers often present overly simplistic and sometimes dishonest analyses of real estate deals. They frequently omit critical expenses from their cash flow calculations, which leads to misleading figures about profitability.

Why is it important to factor in all expenses when calculating cash flow in real estate?

It's important to factor in all expenses because failing to do so can give a false sense of profitability. Real estate investments come with many potential costs—such as repairs, vacancies, and property management—that must be included to accurately assess whether a deal is truly profitable.

What are the three main buckets to consider when calculating real estate cash flow?

The three main buckets to consider are: Debt Service (mortgage payments), Operating Expenses (costs for maintaining and managing the property), and Property Management (which is often included in operating expenses but can be considered separately).

How can new real estate investors ensure they are accounting for expenses conservatively?

New investors should use conservative estimates for costs, assuming the worst-case scenario. This approach ensures they are prepared for unexpected expenses, such as higher repair costs or extended vacancies. For instance, planning for an 8% vacancy rate annually can help create a safety net.

What is the significance of property management fees in cash flow analysis, and should investors always include them?

Property management fees are significant because they can greatly impact profitability, especially if investors plan to hire a property manager in the future. Even if an investor initially plans to self-manage, it’s advisable to include property management fees (typically 8-10%) in their calculations to prepare for potential changes.

How does Dave Meyer recommend handling unforeseen expenses like repairs or maintenance?

Dave Meyer recommends setting aside reserves for repairs, maintenance, and capital expenditures. He emphasizes being proactive by estimating these costs conservatively to avoid cash flow surprises when unexpected repairs or replacements occur.

What is the general range of a good cash on cash return for real estate investments in today's market?

In today's market, a good cash on cash return would be in the range of 3-6% for properties in good neighborhoods. For properties in less desirable or riskier areas, investors should expect higher returns, ranging from 6-8% or even more.

Why does Dave Meyer recommend using conservative inputs in real estate analysis?

Dave Meyer recommends using conservative inputs to ensure that cash flow projections are realistic and account for the worst-case scenario. By preparing for potential setbacks, such as repairs or vacancies, investors can avoid disappointment and better assess whether a deal is worth pursuing.

What are some specific expenses that influencers commonly omit when analyzing real estate deals?

Influencers often omit expenses like repairs, maintenance, capital expenditures (for major repairs or improvements), turnover costs (for tenant transitions), vacancy, and utilities (if the landlord is responsible for them). These omissions can result in overly optimistic cash flow figures.

How does Dave Meyer suggest investors handle reserves for repairs and vacancies?

Dave Meyer advises investors to set aside a separate fund for repairs, maintenance, capital expenditures, and vacancy. By earmarking this money specifically for these purposes, investors can avoid mistakenly thinking of it as part of their profit and be prepared when these costs arise.