So how do you calculate positive cash flow from a real estate investment? Are you saying that cash flow is the difference between your monthly rent amount and your mortgage payment? If so, shame on yourself.

There are more expenses to managing a rental property than the mortgage payment. Most banks use 75% of the monthly rental amount as a guideline which they believe is a better indication of what you will actually get in the bottom line. For example, if the monthly rent is $1,000 per month, they will say that you have $750 per month of income.

So where does that other 25% go? Well, it goes towards maintenance, availability, administration, taxes, insurance, legal, accounting, and other expenses you would have running a business, and don’t be fooled; real estate investing IS a business.

There is a calculation often used in commercial real estate investing that some of us have adapted to the world of residential real estate investing: net operating income.

The net operating income calculations involved determine what the property’s true income is (not including the mortgage payment).

So, if you had a rental income of $1,000 per month and you subtract taxes, insurance, a reasonable estimate of the effect of vacancies, maintenance, and administration, the number you are left with is your net operating income for that property.

If we calculate this number first, we can use a financial calculator to determine the maximum debt a property can bear with that monthly payment and the interest rate at which we can borrow.

If the amount we can borrow is more than the purchase price (minus what we’re willing to put down), then we can honestly say that the property appears to be cash flow positive. If it’s lower than the purchase price, then we know we either need to put more money down or we have negative cash flow which is really like making a down payment over time in my opinion.

Therefore, the next time you do your investment property analysis, I encourage you to do your own net operating income calculation to determine the cash flow of the potential real estate deal.