Below are the first set of terms to get familiar with.
Net Operating Income The profitability of the property itself. The calcu- lation for Net Operating Income, commonly re- ferred to as NOI, is reve- nue minus expenses. Not too difficult, right?
Cash Flow The amount of money you have left after paying the mortgage, which is also known as debt service.
Revenue If you have a duplex and collect $800 per month for each unit, your revenue is $1,600.
Expenses Some of the more common operating
expenses on a duplex are property taxes, insurance, property management, maintenance and occasionally, utilities.
Net Operating Income = Revenue - Expenses
Let’s say that comes out to $510 per month. In this example, the initial financial review starts with:
Expenses - ($510)
Revenue $1,600
NOI $1,090/mo
Cash Flow = NOI - Debt Service
Debt service is determined by:
Loan to Value (LTV) Why is that important? Let’s say you are buying a property for $160,000 and you’re getting a loan at 80% LTV. That means the bank is going to give you a loan that is 80% of that $160,000, which would be $128,000.
Interest Rate A 4.5% interest rate vs 6.5% interest rate is going to give you a smaller payment because the amount of interest you’re paying every month is less.
Amortization Period The timeline your bank is spreading out the payments until you are done paying. For example, a 30-year amortized loan means that over the course of 30 years, you are going to make the same payment every month, and at the end of 30 years, the balance will be zero.
Net Operating Income = Revenue - Expenses
For our example, let’s say that we are purchasing the property for $160,000 at an 80% LTV at 4.5% interest with a fixed rate 30-year amortization. Our monthly payment will be $649/mo.
Net Operating Income $1,090
Cash Flow $441/mo
Debt Service -($649)
This means you are collecting $220 per door. In the world of small multifamily, it’s ideal to be aiming toward $200-$250 a door, so this is a great place to be! Now, we all know that interest rates are on the rise, so don’t take these numbers as a static “must be.” I’d much rather see you take a smaller cash flow than just sit and watch everyone else take action.
TIME IS OUR BEST FRIEND WHEN IT COMES TO HOLDING REAL ESTATE
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