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Cash Flow Simulation for Investors
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If you're considering investing in real estate rental property, there is a lot of research to do.
Real estate investors must have basic valuation skills to make buy, sell, or hold decisions. Along with my experience and knowledge, and by using spreadsheet tools I can produce an adequate valuation on most income-producing real estate. This would include commercial real estate, and residential real estate purchased as residential rental property.
Valuing real estate using cash flow or capitalization methods is similar to valuing stocks or bonds. The only difference is that cash flows are derived from leasing space as opposed to selling products and services. I can help you weed through prospective investment opportunities.
In full-service leases, tenants do not pay anything in addition to rent. In net leases, tenants usually pay their portion of the increase in expenses for the period after they move into the property. In triple-net leases, the tenant pays a pro-rata share of all property expenses. Need help? Contact Bobby Now!
Whether buying or selling, we produce a valuation model accurate enough to assist in the decision-making process.
Owning cash flow properties is really owning a simple business without having to manage the day-to-day operations. And like any business, the owner must still understand the numbers in order to ensure that the investment is performing well, and know what corrective action to take if it is not.
Comparing the cash flow of investment properties is difficult, even for experienced real estate investors. You may have seen a version of these alluring marketing pitches:
“$3,000 Annual Cash Flow!”
“31% Cash-on-Cash ROI!”
But common sense tells us that things that sound too good to be true often aren’t. How is a real estate investor to know? A little basic knowledge and some due diligence up front will go a long way in answering this question. Need help? Contact Bobby Now!
Some due diligence guidelines:
Property management: For single family homes, property management costs 8 – 12% of the actual rents collected. Markets with higher rents tend to have lower property management fees on a percentage basis. For properties that are self-managed, this cost is much lower. Good property management is the key to minimizing the vacancy rate.
Property taxes: Taxes and tax assessment methodologies vary widely between states and counties within states. Call the county tax assessor’s office where the property of interest is located to learn how taxes are assessed and collected, and get an estimate for the property in which you are interested.
A home inspection will help you understand the condition of the home that you are buying, as all homes require preventive maintenance, repairs and cleaning.
Interpreting Cash Flow
An investment metric related to cash flow which is commonly misunderstood is cash return on investment (ROI), sometimes called cash-on-cash ROI. Cash ROI is the annual before tax cash flow (BTCF) divided by the total initial out-of-pocket cash investment in the property. The initial cash investment is the sum of the down payment, closing costs, and the cost of initial upgrades to the property, if any.
Importantly however, negative cash flow does not necessarily mean the investment is a poor one. If the cash flow is negative and the investor can afford it, it may be worthwhile if the expected appreciation is exceptional.
Many sellers include depreciation benefits in their cash flow calculations in an attempt to derive after-tax cash flow (ATCF), as it makes the cash flow numbers look better. Consequently it is recommended that cash flow be compared on a before-tax basis excluding depreciation. This will provide an undistorted picture of the comparable performance of one property to the next.
**A special thanks to James Kimmons**
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