Understanding Real Estate Cashflow

Do you own a real estate investment and want to increase your positive cash flow? How is this actually calculated? Is cash flow simply the gap between the monthly rental income and the mortgage payment or is there more to it? If these are questions you've pondered, then this post is for you! We'll explain Net Operating Income (NOI) and how it is determined.

Net Operating Income (NOI) is the yearly income produced by a property after accounting for all operational income and subtracting all operational expenses. NOI is positive when the operating income surpasses the gross operating expenses, and negative when the operating expenses exceed the gross operating income. NOI is calculated according to the following formula:

	Projected Gross Income
-	Vacancy
=	Effective Gross Income
+	Other Income
=	Gross Operating Income
-	Operating Expenses
=	Net Operating Income (NOI)

Projected Gross Income refers to the revenue earned from all rent payments. Vacancy and losses are the income lost when residents leave. Effective Gross Income is the rental income that the owner can reasonably expect to receive. Other income includes any revenue collected aside from rent, such as from parking, laundry, late fees, etc. Gross operating income is the total income generated after accounting for a reasonable vacancy factor, as well as all additional income aside from rents. Operating expenses encompass all costs necessary to manage the property such as real estate taxes, insurance, management fees, maintenance, utilities, accounting, legal, etc. NOI is the net result—gross operating income minus operating expenses.

NOI evaluates a property's capacity to generate income from its operations. Unlike other metrics that consider financing and taxes, NOI excludes any financing or tax expenses incurred by the owner making it specific to the property itself rather than the owner or investor.

Certain expenses are excluded from the NOI calculation. These include debt service, as it pertains specifically to the owner and depreciation, which is an accounting entry rather than an actual cash outflow. Reserves for replacement are typically not included in NOI calculations, although many investors consider them, especially when financing is involved, as lenders often factor them into debt service coverage ratios and loan amounts to ensure the property can service debt. Other exclusions are leasing commissions, capital expenditures, and tenant improvements. Calculating NOI helps assess a potential investment property. Once you have the NOI, you can evaluate other metrics such as cap rate, property value, and the maximum debt the property can reasonably support and service.

If Red Herron Property Management can help with your purchase or property management, please reach out via phone, text or email and we would be glad to assist!