Addressing Inconsistent Cash Flow in Commercial Real Estate Investments
For those who invest in commercial real estate, there are an array of perks: passive income and deductions in tax, just to name a few. However, it isn’t always plain sailing and often throws up challenges that you should be aware of if you are looking to invest in real estate. One of those is inconsistent cash flow. To quickly summarise what we mean when we say cash flow; it is essentially the money that goes into and out of your business. To be successful, the money that comes in will need to vastly outweigh what goes out.
For a long time, commercial real estate investment has been perceived to be a highly lucrative way to generate income. However, with the housing market ever-changing, there are things that come into account that can prevent the smooth process that has long been associated with this area of investment. Fluctuations in rental come, combined with operating expenses and market conditions can all lead to a swing in the net profit that an investor generates.
Not only can inconsistent cash flow limit your profit, but it can also lead to other issues such as limited reinvestment opportunities and in the long run can hinder the financial success you are looking for.
So, you may be wondering what the root causes of an inconsistent cash flow are. There are numerous factors that we will look into:
- Vacancy and Turnover Rates- This relates to the number of employees who leave the company. When there are vacancies regarding employees, there can be interruptions in the amount of rental income generated.
- Variable Operating Expenses- Due to fluctuations in marketing conditions, location of property and type of property operating expenses can increase. These include things such as maintenance costs, property taxes and various other operating expenses that come for those who generate income through investing in rental properties.
- Debt Obligations- It is always imperative to ensure your debt structuring is up to a high standard, as poor management of debt can lead to massive financial strain. Changes in interest rates can also throw up unpleasant spike in loan payments, which contribute to cash going out of your business.
- Economic Conditions- Shifts within the economic sphere can impact tenant demand, rent collections and occupancy rates. When we talk about these shifts, we are taking about things such as recessions, inflation and changes in employment rates.
Often there are economic issues that make it difficult to predict a consistent trajectory when it comes to cash flow. This comes with challenges such as financial stress and uncertainty. Finding ways to combat these issues is essential to making sure your CRE portfolio is financially healthy.
The Importance of Cashflow cannot be understated. We are talking about what is, in essence, the life and soul of real estate investment. It gives real estate investors the ability to cover essential business costs, such as operational expenses, debts and money to put back into the properties in order to grow a portfolio. It helps you to tackle adversity (like the four we listed) without finding yourself sinking. Putting in the measures to maintain a consistent cashflow can enable you to stay afloat even if you are met with common financial issues that investors experience.
It is also important for commercial real estate investors to understand why they may face more cashflow issues than those who invest in residential real estate. CRE investors experience more cashflow inconsistency due to its vulnerability to shifts within the market, negotiations with tenants and lease structures which can throw a spanner in the works in regard to revenue streams.
Properties that aren’t able to obtain consistency when it comes to their cash flow pose a higher risk when it comes to investing and a typically more challenging to finance as lenders will normally want to see proof of steady income in order for them to want to offer the desired loan terms.
So, how do we find a solution in order to stabilize cashflow?
There are a number of strategies, both short-term and long-term that can be put in place in order to create a business model where consistent cashflow is, well, consistent!
Quality of tenant and lease structures:
A key to success within commercial real estate investment is to select a high quality of tenant. You can achieve this through securing tenants who have deep pockets.
Alongside gaining a high quality of tenant, you also want to retain them in order to keep generating your desired amount of income. Think about offering incentives, such as reduced rent if they stay a long time, improvements on the property and flexible terms to reduce the amount of vacancy periods in the property. Make the tenant feel valued in order to retain them.
Offer NNN (Triple-Net) leases where the tenant becomes responsible for the majority of the operating expenses. This can prevent a landlord from having to fork out for increase in operating costs.
Portfolio Diversification:
Invest in a variety of property types, such as offices, retail, industrial. This can help you to maintain income in the majority of areas if one area experience downturns that are specific to their market. Basically, don’t put all your eggs in one basket!
Put money into properties in different regions and markets, again this helps you spread out your assets so that if one specific region or market is experiencing issues, the others can help you to keep making money.
Proactive Property Management:
Streamline your operating expenses. This can be done by implementing cost-saving measures which can protect you from unexpected cost increases. Utilize technology by using property management software that can provide real-time cashflow reports. Regularly look after maintenance to prevent one-off big costs.
Debt Structuring and Refinancing
By using fixed-rate financing, you can protect yourself from rising interest rates. You can also refinance your debt when there are periods of low interest rates.
Contingency Planning
Maintain a cash reserve in order to cover unexpected shortfalls that may come as a result of loss of income or increase in expenses.
Stress test your portfolio; this will help you gauge whether or not you will be able to maintain consistent cashflow even if you face adversities.
When we make you aware of potential cashflow problems, we aren’t doing it to scare you out of commercial real estate investment. What we are doing is making sure you know the pitfalls and how to avoid them. Be strategic, look for high-quality tenants, implement portfolio diversification so that you cover yourself if one area is struggling. Not only does consistent cashflow improve your profit, it also puts you in a position to succeed within future opportunities. We hope this blog will help you in the long run to improve your CRE portfolio and encourage you to share this if you think it could help someone!
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Our programs, including CRE Investor Essentials and CRE Investor Mastermind, cater to a range of experience levels—from those just beginning their journey in the real estate market to seasoned investors seeking to refine their strategies and expand their portfolios. We pride ourselves on an investor-first approach, offering insightful market analysis, thoughtful selection criteria, and a commitment to transparency across all market conditions.
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