When you’re evaluating a potential property investment, it’s important to
consider the cash flow and ROI. Here’s how.

If you’re thinking about buying your first real estate investment, there’s
good news. There are lots of good deals out there. But even if a deal looks to
good to resist, you need to be sure you have a firm understanding of the two
significant elements that determine profitability: cash flow and return on
investment (ROI). Otherwise, it’s very easy to misjudge just how profitable the
property will be.

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
* Maintenance
* Advertising
* Tenant repairs
* Payment delinquencies

After you subtract all expenses from the revenue, you’ll know whether you’ll
be making money or paying money. You may ask yourself: 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?

First, the technical definition: 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.

Keep in mind that 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 that the bigger the down payment, the less return you will have on the
investment.

So a new question emerges: 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. Depending on your current and future
financial goals, you can determine the best scenario that suits your needs. In
order to attain this balance, you must have the knowledge and skills to
determine the best scenario.

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.