In this article, we are going to talk about the cash flow of real estate investments. But first of all, let’s try together to answer the following question: what is cash flow ? Without going into the exact definition of the term, it will be admitted here that the cash flow is the difference between your cash inflows and your cash outflows. Applied to a real estate investment, it is therefore the difference between what your investment costs you and what it brings you back . These few basics laid, let’s get to the heart of the matter.
As is often the case with this type of ticket, to make it easier for everyone to understand, let’s take a small example. Here we will follow the adventures of Mr. Dupont.
Did Mr. Dupont make a good deal? What cash flow can he expect to generate each month during the term of his loan?
Gross cash flow is the easiest to calculate. This is the difference between the full monthly payment of his loan and the rent he receives. The rent received by Mr. Dupont from his tenant is €550. He pays his bank 2 installments per month: the monthly installment of his loan and the insurance associated with the mortgage.
Which gives per month:
Of course, not everything is as simple as that. A positive gross cash flow is obviously rather a very good thing. Unfortunately, this is not the money that will actually arrive in Mr. Smith’s pocket each month. No, Mr. Dupont will not earn €27 each month during the 25 years of his credit.
Why then will you tell me? Quite simply because owning an apartment for rent, or any other property for that matter (why not an apartment building?), entails costs. The most classic are:
Net cash flow is the difference between cash inflows and all cash outflows relating to the investment made. First thing to do, report the annual expenses of Mr. Smith for his investment on a monthly basis.
Which gives per month:
Well, it looks like Mr. Dupont is making a pretty good investment. But the latest cash flow still doesn’t represent what will stay in Mr. Smith’s pocket each month.
How will you tell me? We have already removed Mr. Dupont’s monthly credit payment and his insurance. We then removed the other costs related to the investment. What would be left to remove? And I would answer you: taxes!
Before we can calculate how much Mr. Smith will owe in taxes each year on his property income, let’s first calculate how much he earns:
To simplify, let’s say that Mr. Dupont has chosen the flat-rate regime to declare his property income. By choosing this regime, Mr. Dupont can therefore deduct 30% of his property income.
As stated at the beginning of this article, Mr. Dupont has an IMR of 14%. Mr. Dupont will therefore have to pay:
Which gives per month:
For reasons of simplification, as the most picky have probably noticed, I have not taken into account either a probable regular revaluation of rents , or a potential change in tax brackets . I also did not mention the vacation rentals which will occur from time to time and which will leave Mr. Dupont orphan of rents for a few months. The idea was to focus on cash flow, and only cash flow, to allow you to understand the difference between the amounts that can be hidden behind this term.
But let’s continue. We often hear that for an investment to be good, its cash flow must be positive. But the first question to ask is to know what cash flow we are talking about! In the example given, we started with a positive gross cash flow of around €30 to end with a net net cash flow of almost €150, negative this time. Or even a difference between the 2 close to 180€ per month !
The moral of this story? Be careful when you hear about cash flow . The term covers several figures and therefore several truths. If you had to choose just one, it would obviously be net cash flow. But even more, cash flow is not the only financial element to define whether an investment is good or bad, but that will be the subject of a future post…
Is cash flow a determining factor for you when investing in real estate? Have you ever heard of this term?