Doing the Math: Analyzing Cash Flow in Multifamily Investing
Cash flow is a key to a successful investment in multifamily real estate assets, and it’s a good idea for investors to become familiar with all the factors that go into analyzing cash flow. We’ll take a closer look at just what cash flow is and how it can be analyzed to determine the profitability of a property.
What is Real Estate Cash Flow
Simply put, cash flow is the money coming in and going out each month for any given real estate property. Cash flow analysis is used to review these funds to help determine profitability. Incoming funds include rent, late fees, income from vending and laundry machines, and administration fees, just to name a few. Costs associated with running the property are also taken into account when analyzing cash flow. Property taxes, insurance, and maintenance fees make up just some of the many costs that go into operating a multifamily real estate asset.
Net Operating Income
When the books are balanced each month, investors or property owners can determine their net operating income (NOI) to measure profitability. While there are several factors that play into the NOI, it is essentially the gross revenue generated each month minus regular monthly expenses. These expenses don’t include any one-time costs, such as major renovations or any costs that might be written off in the future. Vacancy rates also play into a property’s NOI. If 100% of the units are not leased, the vacancies are counted as lost income. Once expenses are subtracted from the gross income, you’re left with your NOI.
One regular expense not listed in the calculations for a property’s NOI is debt service, which is the amount of money required to pay any loans and interest from financing the purchase of the property. Any review of cash flow for a property should take debt service into account, typically through the analysis of the property’s debt-service coverage ratio (DSCR). The formula for this calculation is the property’s NOI divided by the total debt service. This final number will give you a clear indication of the asset’s profitability. A DSCR that is too low might indicate that a property is over-leveraged and financially risky, while one that is higher indicates the property can cover its debts and then some. Investors can use this information to determine where to cut costs or if increases in rents are needed to generate profitable cash flow each month.
Strategies for Optimizing Cash Flow
There are a number of different ways to optimize cash flow in a multifamily real estate asset. The property management company in charge of handling an asset can evaluate current rental rates to ensure they are at or above current market rates, and additional steps can be taken to reduce the number of vacancies. Renovations can attract new renters willing to pay more for the available units, which can increase monthly cash flow going forward. Of course, there are other more creative ways to bring in more money each month, such as:
- Convert vacant units into short-term vacation rentals
- Add vending machines to common areas
- Charge for premium parking (paid assigned spots closer to the building)
- Convert unused space into paid storage units/lockers for tenants
- Offer paid friends and family passes to amenities, such as pools and gym facilities
Adding new revenue streams can help boost monthly cash flow, and it can also absorb losses when vacancies do come up.
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What It Means for Investors Like You
Understanding how real estate works – including analyzing cash flow – is essential for investors, and that means knowing how your investments make money. Cash flow is one way multifamily properties make money for their investors. It can represent a long-term stream of steady income for an individual property owner, and it can also represent regular profits for an investment group. Real estate investment strategies centered on long-term growth rely on cash flow until a property is ready to be sold at a profit on the market.