What's the difference between cash flow and profit?

One of the things which is often hardest for real estate investing novices to understand (yet something apparent to every kid with a lemonade stand) is that cash is king.

Why? You may have found the most profitable property in the world, but if it will require you to hold on for 10 years in order to get at the profits, in the meantime requiring you to put in cash every month (ie. the property is what we call cash flow negative), you can only get the profits if you have enough cash to last you until 'payday'. Cash is king, and the one with the cash is the one who will own the property at the end to claim the profit.

Here's how it works:

There are 2 sources of profit or loss in a real estate investment. The first source is the capital gain-- when you can sell the property for more than you bought it for. That's the juicy gain you usually hear people talking about. "I bought this place for $100,000 and sold it 6 months later for $200,000!"

The second profit/loss source is operational earnings-- how the property fares on a month by month basis during the years when you earn in. Owning an investment property is no different than owning a business in this way. Your 'sales' is rent, and your expenses are all of the funds which you have to contribute to the property: mortgage interest, utilities, taxes, etc. And don't forget that you have to pay back the principal on your loans, and that occasionally you have to make capital improvements to the property (such as a new roof)-- these items don't contribute to your profit, but they sure require your cash.

Wouldn't it be great if there was a way to not only figure out in advance whether a property will be profitable at the end, but also whether it will be cash flow positive or cash flow negative along the way? Of course! And there is a way... it's called discount cash flow analysis, or financial projecting. It's complicated to do by yourself, but you can use an online cash flow calculator (also known as an investment property calculator) to do the hard math for you.

In order to use this sort of tool, you gather together lots of facts and your best estimates about a property. You plug them into the calculator and it spits back a pro forma (estimated) set of financial statements. These will include income statement and balance sheet, but also a cash flow statement. The cash flow statement will tell you, on a monthly basis, whether you are putting money into, or taking money out of, the property.

Obviously, the best situation in the world is a cash flow positive property, since it basically pays you to own it while it appreciates in value. On the other hand, a cash flow negative property requires that you have enough extra cash on hand to be able to fund it until you can sell it for a profit.

No cash in your pocket == no ability to hang on to claim your profit!

You're in luck! Real Estate Genius-- powerful online real estate investment software will run the numbers for you. Let the Genius do the heavy lifting. You'll just gather the facts, and plug in your assumptions. Visit us online at www.real-estate-genius.com to learn more.