There are a number of decision criteria a real estate investor uses to evaluate multifamily income property, but sound investment decisions all rest on accurate cash flow forecasting. Real estate investors buy a rental property’s income stream, therefore it’s crucial that cash flows (the result of rental activity) are properly measured and the streams received from renting space are accurately computed. Here’s one standardized way to do it. All measures are annualized (annual) amounts.
- Gross Scheduled Income (GSI) Use the full income derived from rents as if the units were fully rented and all rents are collected. For units that are vacant, include them rented at a realistic market rent (GSI is meant to represent the full rent potential).
- Less
- Vacancies and Bad Debts This is a reduction in rental income due to vacancies, nonpayment of rent, or the inability to place a property in service for any reason. It’s best to include some percent of vacancy regardless of whether a property has zero vacancy because most lenders will project some amount of vacancy for income-producing property. Better you do it up front during the investment decision rather than ignore it and have the bank come up with a number later.
- Equals
- Effective Gross Income (EGI) This represents what you project the actual income will be from rents. That is, by using GSI to show all potental rental income at 100% occupancy and then adjusting it for loss due to vacancy, you are computing the rental income you are actually expecting to collect from the property.
- Plus
- Other Income This is income derived from sources other than rents. Coin-operated washers and dryers provided in a laundry facility, for example.
- Equals
- Gross Operating Income (GOI) Think of this as the total income you expect the income property to produce and the full income amount you actually expect to collect to service your operating expenses and debt.
- Less
- Operating Expenses These are expenses required to keep the revenue stream flowing. Property taxes, insurance, utilities, and management fees, for example.
- Equals
- Net Operating Income (NOI) This is the “grand-daddy” and most important calculation to make when doing an income property analysis. It represents the amount of money you have to pay your mortgage after all income is collected and all other expenses are paid. This is what makes capitalization rate a popular return for investment decisions; it measures the ratio of NOI to sale price.
- Less
- Debt Service The annual loan payment (or loan payments) including principal and interest.
- Equals
- Cash Flow Before Tax (CFBT) This is the actual cash, or money in the bank, that is left over at the end of the year after all expenses and debt service (except depreciation and income taxes) are deducted from the property’s income stream.
- Cash Flow After Tax (CFAT) This is the spendable cash from the investment after consideration for tax (shelter). We won’t elaborate here, but will provide a sample cash flow statement that shows the calculations for you to preview.
