Book of the Week: What Every Real Estate Investor Needs to Know About Cash Flow... And 36 Other Key Financial Measures
16 May 2016
This week, I read What Every Real Estate Investor Needs to Know About Cash Flow… And 36 Other Key Financial Measures by Frank Gallinelli, Columbia professor and founder of realdata.com, founded in 1982. Another real estate with a ridiculously long title. I picked up this book to go through the math needed to evaluate whether or not a property will make a good investment. The book is separated into two parts. The first part is 100 pages of content and the rest of the book goes through 37 different calculations. Most of those calculations are basic like how to calculate compounded interest. The Four Ways to Make Money in Real Estate There are only four ways to make money in real estate.
- Cash Flow - cash you put in minus cash you get out of the property
- Appreciation - future resale price minus original purchase price
- Loan Amortization - total mortgage payment minus interest paid
- Tax Shelter - money you get from taking advantage of tax laws
Annual Property Operation Data (APOD) In order to make sound financial decisions you need data. The APOD helps you calculate the net operating income (NOI), the gross operating income minus operating expenses (mortgage payments and capital expenditures are not expenses). INCOME | |
—|—|—
Gross Scheduled Rent Income | 19,200 | 100.00%
TOTAL GROSS INCOME | 19,200 | 100.00%
VACANCY & CREDIT ALLOWANCE | 576 | 3.00%
GROSS OPERATING INCOME | 18,624 | 97.00%
EXPENSES | |
Insurance (fire and liability) | 800 | 4.30%
Repairs and Maintenance | 250 | 1.34%
Taxes | |
Real Estate | 1,270 | 6.82%
Utilities | |
Electricity | 130 | 0.70%
Fuel Oil | 2,550 | 13.69%
Sewer and Water | 200 | 1.07%
TOTAL EXPENSES | 5,200 | 27.92%
NET OPERATING INCOME | 13,424 | 72.08%
Comparing APOD percentages between properties helps you identify anything that is out of the ordinary. Is the property using more heating oil than necessary? Are the repair cost out of line or suspiciously low? Return on Investment This is what is important for an investor. The problem is there are many different metrics and ways to evaluate an investment.
- Payback Period - $100,000 initial investment with $20,000 positive cash flow per year gives you a five year payback period.
- Cash-on-cash Return - Cash flow before taxes divided by cash investment
- Capitalization Rate - net operating income divided by value
- Discounted Cash Flow - present value by discounting future cash flows by the discount rate.
- Internal Rate of Return - wraps things nicely to account for the time value of money
If you want, you can use the excel templates on realdata.com. The problem is that an accurate analysis of a property requires knowledge about the future. That is hard to predict. Purchase What Every Real Estate Investor Needs to Know About Cash Flow… And 36 Other Key Financial Measures on Amazon.com or check it out from your local library.