When investing in commercial real estate, it's essential to project the property's potential cash flow accurately. Cash flow projections are crucial for determining the property's profitability and making informed investment decisions. In this post, we'll explore five steps you need to know to determine the projected cash flow of a commercial real estate investment property.
Calculate Gross Potential Income
The first step in projecting cash flow is calculating the gross potential income (GPI) of the property. This includes the total amount of rental income the property can generate in a year. To calculate the GPI, multiply the total number of rentable square feet by the rental rate per square foot per annum.
Determine Vacancy Rate
After calculating the GPI, you need to determine the expected vacancy rate of the property. The vacancy rate is the percentage of time the property is expected to remain unoccupied during the year. This can be affected by factors such as location, property condition, and market demand. To determine the vacancy rate, research the local market and assess the property's specific characteristics. Local real estate agents in the local market area are a good source of this information.
Calculate Effective Gross Income
Once you've determined the GPI and vacancy rate, you can calculate the effective gross income (EGI). EGI is the income generated by the property after accounting for vacancies and any other income that may be lost due to factors such as concessions or rent abatement. To calculate EGI, subtract the vacancy rate and any lost income from the GPI.
Determine Operating Expenses
The next step in projecting cash flow is to determine the operating expenses of the property. This includes expenses such as property taxes, insurance, maintenance, repairs, and management fees. To estimate operating expenses, research similar properties in the area and consult with professionals in the industry to get an accurate estimate. One trap many novice investors fall into is not using the updated assessed value to compute future property taxes.
Calculate Net Operating Income
Finally, you can calculate the net operating income (NOI) of the property by subtracting the operating expenses from the EGI. NOI is an essential metric for evaluating the property's profitability and estimating its value. To calculate the property's potential cash flow, subtract any debt service payments and capital expenditures from the NOI.
Projecting cash flow is a crucial step in evaluating the profitability of a commercial real estate investment property. By following these five steps, you can accurately determine the projected cash flow of the property and make informed investment decisions. Remember to conduct thorough research, consult with professionals in the industry, and account for potential risks and uncertainties when projecting cash flow. With a solid understanding of these steps, you'll be well on your way to success in the commercial real estate market. So, are you ready to take on the challenge of projecting cash flow in commercial real estate?