This is pure real estate investing logic.
Namely, that no prudent real estate investor would ever make an investment in a rental property without some assurance that the cash flows produced by the real estate investment property will generate some amount of cash flow capable of yielding a favorable return on investment moneys spent.
Bear in mind, real estate investors are in the business of making money. That they invest in rental income properties to make money. As a result, their investment decisions are always contingent upon the amount of cash flow the rental property is expected to generate – whether monthly, annually or at the end of the day (when the property is disposed of).
But it is also true that real estate cash flow is evaluated two ways depending on whether or not the investor’s income taxes are considered.
- Cash flow before taxes
- Cash flow after taxes
In this article we’ll summarize both real estate cash flow evaluations with their formulas so you at least get a general understanding how they are derived and why investors typically look at both when making an investment decision.
Real Estate cash flow is essentially all of the cash inflows produced by a real estate investment property less all of its cash outflows.
– Cash outflows
= Cash flow
Think of it as all the money flowing in from the property such as rental and other incomes less all the money flowing out over the course of holding the property like operating expenses, debt payment, and capital additions and you’ll get the idea.
Cash flow before tax (CFBT) doesn’t take into consideration the owner’s tax liability. In other words, it is the cash flow the real estate investor will collect from the investment property but will have to claim as income and therefore will still be liable to the IRS. This is usually what is meant when speaking about cash flow.
Net Operating Income
– Debt Service
– Capital Additions
+ Loan Proceeds
+ Interest Earned
Cash flow after tax (CFAT) does account for the investor’s tax liability and therefore represents the amount of money that the real estate investor will pocket after the IRS is paid and satisfied. Therefore it represents spendable cash from the investment. It concerns a separate tax calculation for tax liability (the investor’s obligation to the IRS based upon taxable income) but we will not discuss that in this article.
– Income Tax Liability
Rule of Thumb
Creating a real estate analysis with both CFBT and CFAT is optional. But it’s generally true that serious real estate investors prefer to know what revenue they can expect to pocket after the IRS takes its tax bite, so it might be a good idea for you to account for both in your real estate analysis.
So You Know