Given the recent drops in the stock market, I thought I would explain an alternative (and more secure) method of investing your money.  Here is the formula for how to invest in real estate and how to derive cash flow from it.

This form of investing involves buying a property (an apartment, a house, etc.) and renting it out.  The rent payments cover the mortgage, insurance, and tax payments.  What is left over after you subtract the mortgage, insurance, and tax payments is passive income.  That is the kind of cash flow that liberates people from jobs. 

This is not “flipping” properties or buying foreclosed properties.  Investing in real estate for cash flow involves buying and holding a property.  There are various details, including incredible benefits such as tax-free rental income and 1031 exchanges, associated with this type of investing that I have covered before. 

In broad strokes, this is how this investment works. 

The Initial Investment

If you buy a one-bedroom apartment for $80,000, and you put 10% down ($8,000), you can make $125.67/month in passive income and almost a 19% annual return on your down payment.

The Expenses

After putting 10% down, you obtain a mortgage for the balance of the purchase price ($72,000).  The monthly payments for a 30-year mortgage at 5.75% (rates are currently at 5.5%) are $420.17.  Let’s assume that annual taxes on the apartment are $1,600 (based on 2% of the property’s value), and homeowners’ insurance is about $250 annually (the national average is $481).  Thus, your monthly escrow payments for taxes and insurance are $133.33 and $20.83, respectively. 

Putting all these numbers together, total monthly expenses are:

$420.17 + $133.33 + $20.83 = $574.33. 

Renting It Out For Cash Flow

The rental rates for one-bedroom apartments depends on local property values.  Since we’re using averages, let’s assume that you can rent this apartment for $700/month.  If you subtract your expenses, this is what your monthly passive income will look like:

Rent ($700) - Expenses ($574.33) = $125.67.

Your monthly passive income, or cash flow, is $125.67.  (Remember that you make this money whether or not you get out of bed in the morning.) 

Return On Your Investment: Cash-On-Cash Return

The fun doesn’t stop there. 

Recall that you invested $8,000 in this apartment when you bought it.  You can calculate your annual return on that investment.  This is called cash-on-cash return.  To arrive at this figure, you divide the annual cash flow from the property by the initial amount invested.  Here, your monthly cash flow is $125.67.  To calculate the total annual cash flow, multiply your monthly cash flow by the number of months (12):

$125.67  x  12 = $1,508.04.

Your total annual cash flow is $1,508.04.  To calculate cash-on-cash return, divide this number by the initial amount invested ($8,000).  Thus,

$1,508.04/$8,000 =  0.188.

Your cash-on-cash return is 0.188, or 18.8%. 

An annual return of 18.8% on an investment of $8,000 is VERY GOOD.  That beats practically every index fund and about 80-90% of mutual funds.  Furthermore, you may be able to keep that return tax-free, and you also benefit from the annual appreciation of the property.                  

That, in a nutshell, encompasses how to invest in real estate for cash flow.  It is a very lucrative (and secure) method of investing, and it is a perfect example of leveraging money for passive cash flow.

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