Cash Flow = NOI – Debt Service
Cash flow is equivalent to NOI adjusted for the expense of debt service. Specifically, cash flow is the NOI minus the debt service payments. As might now be obvious, cash flow is the total profit you will see at the end of the year from this property. As is also probably obvious, the higher your debt service payments (the larger your loan, higher your interest rate, or shorter your amortization period), the smaller your cash flow. If you pay all cash for a property (don’t take any loan), your cash flow will equal the NOI – this is the maximum cash flow on the property.
Monthly debt service= $2049
NOI = Income – Expenses
= $48,350 – $11,500
= $36,850 (the property generates $36,850 per year)
Judging by our financing data, our monthly debt service would be $2049 on this property, and therefore our annual debt service would be $24,588. For this property, our cash flow would be:
Cash Flow = NOI – Debt Services
= $36,850 – $24,588
= $12,262 (annual cash generated)
So I know what you’re thinking:
Sealey, paying all cash will minimize my debt service (it would be $0) which would therefore maximize my Cash Flow. So, if paying all cash maximizes Cash Flow, and if you have the means to pay all cash for the property, why wouldn’t you?
Great question, I”m glad you asked.…
Rates of Return
Cash flow isn’t the only important factor when it comes to analyzing the property. What is more important than cash flow is rate of return (also known as return on investment or ROI). Think of ROI as the amount of cash flow you receive relative to the amount of money the investment cost you (your “basis”)….to be continued