Benchmarking cash flow (3) – Examples

In my previous posting “benchmarking cash flow (2)” with thelink below, we discussed how to calculate Cap Rate or CR% and Equity Return orER%.

http://blog.wenxuecity.com/myblog/61110/201212/25655.html

I know that this might be a boring topic with a lot oftedious work. It can also be painful especially when you review some of yournon-performing assets. However this is really a good tool to understand howwell you are doing with your real estate assets and improve the overallperformance by focusing on low performance assets in the next year. Furthermore, you will also understand which parts of cost factors are really affectingthe performance. For example, is it repair related or financing related issue?

 

An Example of a rental property below illustrates how thecalculation works.

 

You bought this property with closing cost in amount of $117,522ACB (Adjusted Cost Base). Suppose that you received rent deposit in amount of $15,993for an entire year.  Your operatingexpenses or OE is   $3,576. Therefore theNOI is $12,417 = ($15,993 - $3,576) and CR% is 10.6% = ($12,417/$117,522).

 

Let’s say, your Interest Cost or AFI (Annual FinancingInterest) is  $3,601 for the year. Theremaining principal of loan balance is $66,406. Equity amount is $51,116 =($11,522 - $66,406). Therefore the net cash flow is $8,816 = ($12,417 - $3,601)along with ER% 17.2% = ($8,816 / $51,116).

 

As you can see, the cap rate for this property is around 10%which has nothing to do with financing. i.e., it doesn’t matter if you boughtthe property with cash or a loan. This CR% may vary from year to year dependingon other cost factors such as management costs, maintenance costs etc. 

On the other hands, the ER% is better than CR% in thisexample. In other words, you have a good leverage by borrowing someone else’money to invest in this property to get a return as good as 17.2% which is muchbetter than 10.6%. Please note that ER% is not always better than CR%. If theAPR was too high, you may get lower ER%. Sometimes ER% could be negative if AFIis too high especially true when you use hard money loan to leverage yourfinancing. By using this tool, you can adjust financing strategy to optimizeER% accordingly.

 

In the next posting, I am going to talk about how to use ScheduleE to fill in the data for this calculation.