Cash flow is a critical component of any investment analysis. Real estate cash flow is calculated as follows:

Cash Flow = Net Operating Income (NOI) - Vacancy - Debt Service

Net Operating Income
Net Operating Income is the Total Income - Operating Expenses

Income
Real estate investing income starts with the rents, also known as the Gross Scheduled Income (GSI). GSI can be from both the unit itself plus garage rental. Other non-scheduled income sources may include laundry (washer/dryer) and vending machines.

Operating Expense
Operating Expenses are all of the costs associated with the rental unit except for the mortgage.

Investment advisors often calculate Operating Expenses using a rough "industry standard" percentage of rents. This "industry standard" varies from 30% to 45% of rents. While this is useful as a quick "rule of thumb", we calculate as close to actual known expenses as possible. For example, in California, we use 1.25% of purchase price to calculate the "real" property tax an investor buyer will encounter. Other expenses typically include those associated with normal property ownership, such as insurance, property management, HOA fees, water, refuse/recycle, landscaping, pest control, marketing and professional services. In the case of rental property, most of these expenses are also tax deductible! See your tax advisor for details.

Reserves
A prudent investor would also want to include a monthly reserve, which would be like a savings account covering future unanticipated but guaranteed expenses for maintenance and repairs. You are going to have to replace the carpet someday. And the refrigerator will go on the blink eventually. Stay prepared!

Vacancy
Vacancy is calculated as a percentage of time where the rental income is not coming in. While this varies by location, the rental market and how the economy is doing, we default to a 5% vacancy rate, which equates to the unit being vacant about 2.5 weeks out of the year. This is about a month without rents every two years, which is not unreasonable, assuming your average tenant keeps a two year lease. This number can be adjusted on individual calculations in our system.

Debt Service
Debt Service is simply the mortgage payment (principle and interest). It does not include property taxes and insurance, if you have impounds.

Example (monthly)
City: Long Beach
Units: 2
Rents: $4,100
Property Tax: $624
Insurance: $60
NOI: $3,416
Vacancy: $205
Mortgage: $2,210
Cash Flow: $1,001


Analyzer Software
Our SMART Residential Income Property Analyzer^© shows the calculated ratio of Expenses to Rents, and allows the user to manipulate any factor in the cash flow calculation.