Real estate can create income for investors in two ways. First, there’s the monthly rental income from qualified tenants. Next, there’s the potential appreciation in market value over the long-term.
While building equity is nice, most successful real estate investors view appreciation as icing on the cake and focus on cash flow first. That’s because monthly cash flow is much more predictable and controllable, while an increase in market value isn’t always guaranteed.
In this article we’ll look at what several expert sources have to say about the best real estate markets for cash flow, and also take an in-depth look at why so many rental property investors focus on cash flow.
Best Markets to Buy Rental Property
Investing in the right rental property in the right market can generate healthy cash flow and a stronger ROI (return on investment).
Here’s where five leading financial and real estate investing organizations say are the best markets to buy rental investment property in 2020:
The Fool.com lists several factors that make a market a “best place” for real estate investing: housing affordability, wage and population growth, unemployment rate, property value appreciation, and rental yield.
Based on those metrics, the best places for real estate investments are:
- Amarillo, Texas
- Tampa/St. Petersburg/Clearwater, Florida
- Oklahoma City, Oklahoma
- Atlanta, Georgia
- Cedar Rapids, Iowa
- Indianapolis, Indiana
- Jacksonville, Florida
- North Charleston, South Carolina
- Louisville, Kentucky
- Dallas/Fort Worth, Texas
- Reading, Pennsylvania
- District Heights, Maryland
- Allentown, Pennsylvania
- East Orange, New Jersey
- Nashua, New Hampshire
- Cincinnati, Ohio
- Paterson, New Jersey
- New Castle, Delaware
- Rochester, New York
- Hyattsville, Maryland
To learn which markets will be best for real estate investors in 2020, Roofstock reviewed reports from the Urban Land Institute and Realtor Magazine to rank the 10 best overall markets for real estate investors:
- Austin, Texas
- Raleigh/Durham, North Carolina
- Nashville, Tennessee
- Charlotte, North Carolina
- Boston, Massachusetts
- Dallas/Fort Worth, Texas
- Orlando, Florida
- Atlanta, Georgia
- Los Angeles, California
- Seattle, Washington
In addition to researching the best overall markets Roofstock also created best lists for:
- Major capital markets
- Housing markets with a consistent record of capital inflows and transaction volumes
- Real estate markets that are ripe for discovery
- Thrifty choices for investors looking for under-the-radar investment opportunities
- Markets that are consistently meeting expectations
By looking at metro-level real estate studies from the Urban Land Institute, Realtor.com, and the National Association of Realtors, Curbed conducted a meta-analysis of the five best metro areas where homes could make a good investment in 2020:
- Charlotte, North Carolina
- Charleston, South Carolina
- Dallas, Texas
- Raleigh, North Carolina
- San Antonio, Texas
Real estate markets in major global cities are caught in a cycle of high-demand and low-supply, making it difficult for investors to find deals that make sense.
In this article from Forbes, successful executives in the real estate industry from Forbes Real Estate Council shared their insights on the “14 Up-And-Coming Real Estate Locations To Watch” for investment and portfolio diversification:
- Toronto, Ontario (Canada)
- Mount Airy, North Carolina
- Sacramento, California
- Las Vegas, Nevada
- Minneapolis/St. Paul, Minnesota
- New York City
- Sunbelt States including Arizona, New Mexico, and Texas
- Second-tier Southeastern Cities with low cost of living, good accessibility, and low to no taxes
- San Antonio, Texas
- Western Open Land areas in the western region of the U.S. where homebuilders are buying land for future development
- Kansas City, Missouri
- States with ADU (accessory dwelling unit) demand such as California, Oregon, and Washington State
- Gloucester County, New Jersey
- Detroit, Michigan
Why Cash Flow Matters
The two main components of potential profit from rental real estate are cash flow and appreciation. However, investors who put too much focus on appreciation may also incur too much risk.
That’s because appreciation can take years to receive. In the meantime, if a property is overpriced or over-leveraged, monthly cash flow may not be high enough to cover normal operating costs and mortgage payments.
Key benefits of cash flow
A recent article on FOX Business listed several more reasons why real estate investors should concentrate on adding income-earning, cash-flowing properties to their portfolios:
- Cash flow helps protect investors from economic change and the routine cycles that real estate markets move through.
- Rental yields act as a hedge against inflation because annual rents can be adjusted to market and real estate values tend to increase more than the annual rate of inflation.
- Rental property income generated by a tenant can be used to pay the owner’s mortgage and maintenance expenses with any additional positive cash flow remaining as profit.
- Real estate tax deductions for items such as repairs, property management fees, insurance, and non-cash depreciation expenses can help reduce an investor’s taxable net income.
Why Rich Dad likes cash flow
Robert Kiyosaki (author of Rich Dad Poor Dad) says that cash flow – or passive income – is the primary focus for building infinite wealth. That’s because cash flow breeds more cash flow.
In fact, after a certain point in the investing process, recurring cash flow can support an investor’s living expenses and provide the capital to invest in more real estate.
Real estate with cash flow can:
- Be immediately generated the minute the property is rented to a tenant
- Eliminate the fear of running out of money during retirement
- Create the lowest-taxed type of income (although a 1031 exchange can also be used to defer the payment of capital gains tax)
How to calculate true cash flow
Not all cash flow is created equal.
Sometimes beginning real estate investors make the mistake of confusing gross cash flow – or the rent money collected from a tenant – with net cash flow, or the money left over at the end of the day after all of the bills have been paid.
It’s possible for a rental property to have positive gross cash flow, but negative net cash flow if the total cost of owning the property is greater than the income being generated.
Let’s take a quick look at how to accurately calculate the true monthly cash flow of a single-family home:
Rental income $1,500
Mortgage payment (PITI) $900
Property management fee $100
Vacancy allowance $150
Maintenance and reserve $150
Total expenses $1,300
Cash flow (net) $200 per month or $2,400 per year
Earlier in this article we mentioned the risk of focusing too much on potential appreciation.
If an investor uses too much leverage to purchase a property with a small down payment, or over bids for a property, it’s easy to see from the above example how a home with a positive gross cash flow and quickly turn net cash flow negative with a higher monthly mortgage payment.
Financial formulas that use cash flow
Real estate investors have other uses for cash flow besides paying the bills and putting money in the bank.
Accurately calculating and forecasting cash flow impacts a variety of other financial formulas that rental property investors use:
- NOI (net operating income) is another word for net cash flow and is the amount of money generated by an investment property after the cash operating expenses have been paid.
- Cash-on-cash return calculation compares the net cash income earned on a property to the cash invested in a property to calculate the annual rate of return.
- Cap rate formula measures the potential profitability of an investment by dividing the NOI (excluding the mortgage payment) by the market value of a property to compare one cap rate to the cap rates of similar investment property in the same market.
- IRR (internal rate of return) is the percentage rate that compares the net present value of future cash flows to an investor’s required rate of return.
How to Find Cash Flowing Property
The first step in knowing where to look for rental property is to understand the factors that can potentially help an investment cash flow. Signs that a market might be good for cash flowing rental property include:
- Housing affordability indicates the opportunity for investors to buy property at a reasonable price and the potential demand from tenants.
- Wage growth year-over-year should meet or exceed the forecasted rate of rent increases, otherwise tenants may be unable to pay the rent.
- Unemployment rates in good rental markets are at or below the national unemployment rate and indicate a strong job market.
- Population growth is a sign that more people are moving into a market for job opportunities, low cost of living, or a higher quality of life.
- Rental yield is the percentage of rental income compared to property market value, so the higher the rental yield is the more cash flow there is being generated.
- Property value appreciation can be measured by the change in median home values over the long term, creating a potential increase in equity to boost overall ROI and the capital to purchase more property with cash-out refinancing.
Locating Rental Property with Strong Cash Flow
Once an investor has narrowed down markets that are good for cash flow rental property, the next step is to negotiate a good deal.
Successful real estate investors know that true profits are made when a property is purchased, not when it’s sold. That’s because if an investor buys above market price, they’re paying more for the property over the entire holding period and losing profits by leaving money on the table each month.
Ways to find rental property with the potential for good cash flow include:
- Owners in distress that are desperate to sell due to job loss, divorce, medical bills, or deferred property maintenance.
- Pre-foreclosure and REO (bank owned) real estate may offer investors the opportunity to buy below market, although investor competition for foreclosure property can make deals difficult to find.
- Buying rental property from wholesalers and fix-and-flip investors is another rent-ready option, but these types of investments won’t generate cash flow until they’re rented to a good qualified tenant.
Another option is to purchase rental property already occupied by a tenant like the single-family homes listed for sale on the Roofstock Investment Property Marketplace.
Using an online platform like Roofstock helps take the guesswork out of real estate investing. And because the listings are pre-vetted and can be managed by local property management companies, investors increase the likelihood that long-term cash flow will be healthy and strong.
You can also easily view cash flow projections for each property listed on the marketplace: