Investment Property
Cash Flow Analysis

Learning the ins and outs of how to perform a cash flow analysis on an investment property is a big advantage (or a necessity) when investing in rental property. It will tell you just how well your rental property will perform financially. After all, the main reason for investing your hard-earned money in residential rental property is to increase the value of your investment over time. In the end, it all boils down to "dollars and cents".

By performing a cash flow analysis on an investment property, you'll know if the property will make you money each month (positive cash flow) or cost you money each month (negative cash flow). The results of your analysis will also give you a good indication of what the market value of the property is. This is crucial information to know before making any offer to purchase an investment property.

In order to perform an investment property cash flow analysis, a financial analysis form that is set up like a ledger should be used. Such a form will provide specific areas for each of the following income and expense line items…

Income Items

The schedule gross income for the rental property is the first line item at the top of the form. This is the amount of rental income that the property should produce if it is 100% occupied with tenants during the entire year.

The schedule gross income will be reduced by any vacancy factor and collection losses . When analyzing a property, this is necessary to give yourself a certain "safety factor" by allowing for vacancies and any tenants who fail to pay rent.

The vacancy factor and collection losses are then subtracted from the schedule gross income. The resulting dollar amount gives you the effective gross income that is actually produced by the property for the year.

Expense Items

The second portion of the investment property cash flow analysis accounts for all the expenses that must be paid in order to run the property. The yearly operating expenses of the property are subtracted from the effective gross income. This yields the net operating income of the property, or all the money that’s left over before paying the mortgage.

Quicken rental property management software is a great way to organize your rental income and expenses in one place. You'll always know how well your rental properties are performing - whether you have one or 100!

Financing and Depreciation

We're now at the last section of the financial analysis form. This is where we'll subtract the mortgage finance expenses , which consist of both mortgage interest and mortgage principal , from the net operating income. The resulting amount yields the bottom line cash flow , or gross spendable income that is produced by the property. This is the number that we're after - it tells us if the property will actually make us money each month (that we can spend or save), or if it will cost us money to support each month (negative cash flow).

Lets now complete this last section of the financial analysis form. The annual mortgage principal is added to the gross spendable income (or cash flow) from above. The sum of these two amounts yields the annual gross equity income for the property. Now, the annual depreciation that is taken for the property is subtracted from the gross equity income. This yields the real estate taxable income for the property. If this number is negative it can be used to lower your income taxes.

That wraps up the basics of how to use a financial analysis form. For some great, in-depth information on investment property cash flow analysis, please check out The Landlord's Library book collection.

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