Rental Property Cash-Flow Analysis for Military LandlordsUpdated: April 27, 2022
Military members frequently become landlords. Some transfer duty stations and decide to rent out their homes. Others take active measures to find, buy, and lease investment properties. Regardless of how you become one, successful landlords need to understand how to measure a property’s cash flows. As such, we’ll use this article to explain rental property cash-flow analysis for military landlords.
Specifically, we’ll discuss the following:
- An Overview of Rental Property Cash-flow Analysis
- Cash-flow Analysis Step 1: Project Monthly Rents
- Cash-flow Analysis Step 2: Determine Monthly Debt Service
- Cash-flow Analysis Step 3: Project Monthly Operating Expenses
- Cash-flow Analysis Step 4: Account for Reserve Transfers
- Cash-flow Analysis Step 5: Do the Math and Make a Decision
- Final Thoughts
An Overview of Rental Property Cash-flow Analysis
As a future military landlord, it’s easy to become overwhelmed by seemingly complicated real estate jargon. But, a cash-flow analysis shouldn’t overwhelm you. Simply put, it’s a way to make sure that the amount of cash you receive from a rental property every month exceeds the amount you spend. Do your monthly rents cover all the cash you need to spend on the property?
Of note, cash-flow analysis differs from tax analysis for two main reasons. First, when you pay your mortgage, a portion goes to interest and a portion to loan principal. The loan principal portion is not tax deductible, but you still need to spend that cash every month. Next, depreciation reduces your taxable income, but it’s a cash-less expense. So, while depreciation affects your taxes, it doesn’t directly affect your monthly cash flow. (NOTE: Depreciation indirectly affects cash flow when considering the associated annual tax savings, but a basic cash-flow analysis does not need to go into this level detail).
Cash-flow analysis proves particularly important for military landlords. Many of these individuals don’t choose a rental property. Instead, they buy a home, live in it as their primary residence, then decide to rent it out when they PCS. However, a good home does not equal a good rental property. Enjoying living somewhere does not mean that the local rental market conditions will support converting a home into rental. As a result, these potential military landlords must understand cash-flow analysis to make the decision: sell your home or rent it out when you PCS?
In the remaining sections, we’ll outline the steps to complete a basic cash-flow analysis for a rental property. Once you understand the concept, you can create a simple Excel spreadsheet to conduct A) a cash-flow analysis for a single home; or B) comparative cash-flow analyses for multiple potential rental property purchases.
Cash-flow Analysis Step 1: Project Monthly Rents
Begin your cash-flow analysis (and any budgeting process) with the top-line results: monthly rents. With the massive amount of real estate information available online, you can estimate future rents fairly easily.
Using Zillow, Redfin, or another online rental platform, set up a search for available rentals in your neighborhood. Make sure that the property parameters (e.g. bedrooms, bathrooms, square footage, garage, etc.) are as similar as possible to your target property. Once you have a few comparable properties (three minimum, but more is better), add them up and divide them to get the average asking rent in your area.
But, you won’t use this average as your projected rent. With cash-flow analysis, it’s always better to err on the side of caution. As such, we recommend using a 10% discount. If the average asking rents for similar homes in your neighborhood is $2,000, deduct $200 and use $1,800 for your analysis. If the numbers work with this conservative estimate, anything above that 10% discount is just a bonus.
Enter this number in the top line of your spreadsheet.
Cash-flow Analysis Step 2: Determine Monthly Debt Service
Next, you need to determine your largest single monthly cash outflow – debt service. If you already own your home, you know the size of your monthly mortgage payments. If you’re considering buying a rental property, you’ll need to make some assumptions and use a loan calculator. In particular, you’ll need to assume 1) interest rate, and 2) closing costs (which, if rolled into your loan, will affect monthly payments).
Combining these assumptions with the loan amount (based on the purchase price and down payment) and loan term (e.g. 15-year, 30-year, etc.) allows an online loan calculator to solve for the monthly payments. If you prefer a more hands-on approach, you can also solve for this number with Excel’s PMT function (just make sure to divide it by 12 for the monthly amount).
Enter this payment amount immediately beneath the projected monthly rent on your spreadsheet.
Cash-flow Analysis Step 3: Project Monthly Operating Expenses
After confirming your mortgage payment, you need to project monthly operating expenses. Some of these you’ll know, and some you’ll need to estimate. While not an all-inclusive list, here are the most common rental property operating expenses:
- Insurance: An agent can provide you a quote for an accurate estimate.
- Property taxes: In most municipalities, you can find property tax records online. Find the current tax-assessed value of your property, multiply it by the local tax rate, and divide that by 12 for the monthly amount.
NOTE: With most residential mortgages, insurance and property taxes are paid from an escrow account and will be included in your monthly mortgage payment. This doesn’t change the fact that you need to account for these cash outflows in your analysis.
- Property management: If you choose to hire a property management company, ask for their fee structure up front. Most companies charge a percentage of monthly collected rent (8% to 12% is typical).
- Homeowner Association Fees (HOA): You can find this information on an online property listing. If working with a real estate agent to purchase a rental property, you can see this info in the MLS listing for the property.
- Landscaping and Utilities: For most single-family rental properties, landlords “pass through” these expenses directly to the tenant, so they shouldn’t factor into your cash-flow analysis. However, if you offer to pay for any of these items, you’ll need to account for the expenses in your analysis.
Enter all of the above items on your Excel spreadsheet beneath debt service. While you can lump operating expenses into a single cash outflow, a line-by-line accounting provides far more fidelity and analytical value.
Cash-flow Analysis Step 4: Account for Reserve Transfers
You likely noticed that we didn’t mention any maintenance payments in the operating expenses section. Due to the sporadic nature of these expenses, we instead recommend rolling maintenance into a general monthly reserve transfer. Every month, you should transfer funds from your rent bank account into a reserve account to plan for the following issues:
- Maintenance expenses (e.g. broken garbage disposal, chipped paint, etc.)
- Capital improvements (e.g. new roof, replaced HVAC system, etc.)
- Vacancy (periods when you don’t have a tenant in the property)
These situations can’t necessarily be planned for on a monthly basis. But, they will affect your cash flows at some point in time. To smooth your cash flows out, transfer a flat reserve amount every month. That way, whenever one of the above scenarios arise, you simply transfer funds out of your reserve account without an impact on current cash flows (or, worse, needing to put a repair on your credit card).
You can think of these reserve transfers as your “peace of mind” transfers. Plenty of rules of thumb exist for reserve transfer size, but we recommend 10% of rents. For instance, if you use the above $1,800 rent for planning purposes, account for a $180 reserve transfer in your cash-flow analysis. Then, when you actually lease your property, make sure that you set up the associated automatic bank transfer.
Whatever you decide on for the reserve amount, add it to your spreadsheet beneath the operating expenses section.
Cash-flow Analysis Step 5: Do the Math and Make a Decision
This is the easy part. Create a bottom-line formula on your spreadsheet that subtracts the sum of all cash outflows from the projected monthly rent. At a minimum, the projected rents should cover all projected cash outflows, including the reserve transfers. If not, the property will likely not make a great rental, as it’ll require you to continue dumping more and more cash into it to cover these monthly shortfalls.
Certain investors also require a level of cash flow above monthly cash outflows. In other words, after making all cash payments in a given month, these investors want some cash remaining. If you have a minimum cash-flow requirement, you can also add this to your spreadsheet.
For instance, some investors require 10% of rents as a minimum cash flow (e.g. $180 remaining based on the above $1,800 rent). Simply add another formula dividing the remaining cash in the final spreadsheet cell by the monthly rent, multiply it by 100, and you’ll have your percentage-of-rent cash return. If you want 10% but the spreadsheet kicks out 5%, you know the property fails to meet your investment criteria.
For military landlords, it’s important to understand that not all homes make great rentals. By using the above cash-flow analysis techniques, you evaluate whether or not a property will make sense as a rental. Consequently, before deciding to convert your home into a rental property after a PCS, run the above cash-flow numbers.
Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.