I work with a lot of investors and a lot of what I call ‘accidental investors’ - people who had no intention of becoming a real estate investor, but do so when they move and rent out their property because it ‘almost covers the mortgage’. I cringe when I hear that phrase.

They keep the property as a rental, not because it’s a smart investment, but because they have some emotional attachment to the home. They think if they can ‘almost cover the mortgage’, they will have a big profit down the road.

Now, don’t get me wrong, I’m a strong advocate for investing in real estate and have many friends and clients that are wealthy today because of their investments. However, there is a right way and a wrong way to invest in real estate.

Most investors I know invest primarily for cash flow and secondarily for appreciation. Smart investors know their numbers and only invest in a property if the numbers make sense. The whole point of investing is to make money.

The mistake accidental investors make is that they don’t take a full inventory of the costs involved and only focus on covering their mortgage payment. Here are a few other expenses that affect cash flow:

• Insurance. As an investor, you want to get landlord insurance to cover your increased risk exposure.
• Capital Expenditures (Cap Ex). Big ticket items like a new HVAC system. For a condo, these will be less than a single family home.
• Repairs. The cost of the plumber you call on Saturday night fits into this category.
• Property Taxes.
• Condo/HOA Fees.
• Property management. Some people prefer to self-manage their own properties. That’s fine but just remember your time is worth something.
• Vacancy. This is a big one that is easily overlooked. Several weeks of vacancy can really eat in to your return.
• Real estate commission. Unless you are going to find your own tenants and screen them, you will be hiring an agent to help you here.
• Legal fees. Evicting a problem tenant has associated costs too.

So let’s use some real world numbers and see what the return is. Let’s assume you bought a 1BR condo in Clarendon a few years ago for $425,000 and put 20% down at the time with a 4.0%, 30 yr fixed mortgage. Let’s also assume it is worth $450,000 today and you could rent it for $2,100/month.

The Principal & Interest payment (i.e. the mortgage payment) is $1,623. So, after you pay your mortgage, you have $477 remaining each month. Not bad, right? Wrong !

Lets add in the other numbers smart investor use in their calculations:

• Insurance: $25/mon
• Condo Fee: $330/mon
• Property Taxes: $358/mon
• Cap Ex: 2%
• Repairs & Maintenance: 2%
• Vacancy: 5%
• Management: 8%

For future assumptions, we will use 3% annual growth for income, appreciation and expenses and a 6% sales expense.

The result: a negative cash flow of -$593 per month and cash-on-cash return on investment of -8.38%.

You can see the full report for this example here.

Even after 15 years, you would have a projected negative cash flow of -$789 per month and a cash on cash ROI of -0.93%.

Would you make an investment in an asset that would cost you money each month! I wouldn't either. Yet, I see plenty of people do it every day without realizing it.

To be fair, I didn’t factor in the tax savings since that will vary with each individual and the new tax law has many changes that people are still trying to figure out.

I also didn’t factor in any expenses for finding new tenants (real estate commissions or advertising costs). If you’re lucky, you will have the same tenant for many years. I recently met a landlord that has had the same tenant for 28 years!