A Run Through How a Rental Property Can Provide Financial Returns

Each of the items below will show you a financial facet of owning a rental property. We are using a fourplex as our example property. All of the examples below will be based on these facts:

  • Property purchased for $325,000, with $65,000 down & $260,000 financed.
  • This is a 30 year fixed rate loan at 6.5% interest.
  • The four units are identical and rent for $900 per month each.

So, let's get going with our financial analysis of this real estate investment.

Rental Net Income Cash Flow Calculation

Musician Relaxing on Living Room Couch with Laptop
Cavan Images/ Iconica/ Getty Images

This is a break out of the rental cash flow on our example property. This is not a tax liability calculation, but a straight out of pocket cash flow problem. In other words, we'll take out our mortgage payments, though all of that will not be deductible. We want to see the difference in actual cash flow in and out of our pocket.

Your goal of course is to create a positive flow of cash you can deposit into the bank every month for the life of your ownership of the property.  Every cash outflow and inflow is calculated and the amount left over should be a reasonable return on your investment.  Yes, you expect to sell at a profit too, realizing appreciation in value over your ownership period. More

Rental Property Example Depreciation Deduction Calculation

Rental Home Bank
Rental Home Investing. iStockPhoto

We run you through the calculation of depreciation on the fourplex structure, as well as how it reduces our income tax liability on the cash flow in the previous step. We put back the mortgage payment in this calculation to begin looking at this from a tax perspective.

The depreciation deduction is a valuable component in our property analysis.  For people in high tax brackets with other investments, it may even allow reducing the profits from other investments.  Of course, contact an accountant about this.  However, when the costs plus depreciation actually are more than the profit number for taxes, you have leftover losses to use against other investment income.

It's not actually a cash loss, as the depreciation isn't cash out of pocket.  It's a calculated number treated as an expense for tax purposes.  Since you didn't spend it, you can still have positive monthly cash flow while showing an operational loss for taxes. More

The Mortgage Interest Deduction on Our Rental Property

Mortgage Interest Deduction
©CanStockPhoto

Now we consider our deduction for the mortgage interest on our fourplex. The result, without any other deductions any particular owner may bring into play, is our approximate tax liability. Note that we've reduced it considerably and realized a net positive cash flow after taxes.

Even vacation properties you'll be using allow this deduction, so it can be advantageous.  The overwhelming evidence is that most real estate investors are in the game for profits, and that those profits are in large part due to advantageous IRS rules for real estate. More

Are You Still on the Fence?

It's a big decision to move from the comfort of buying and selling stocks or mutual funds to active real estate investment. I'm not pushing this at anyone. However, if you want to get some more education from real people who are doing it, join one of your local real estate investment clubs. Talking to others who are actively doing this type of investing will help you to make your decision. You'll meet highly experienced rental property investors as well as newbies. You'll also get some education from club libraries and guest speakers.