Lately, I have run across many, many great apartment deals all over the US with tremendous cash flow and upside. More so than last year or the year before! I wondered “why”? I found the answer to be quite simple. Many investors, who bought these apartment investments, didn’t do the basics to ensure the success of their investment. I was surprised that the single most important thing they didn’t understand is calculating cash flow.
Isn’t that obvious? Well, to you and me it is. But for them, all I can think of is that they were too over-enthusiastic and wanted to be “an investor”. And they skipped over taking their time to get an advisor to help them. But the basic knowledge of calculating cash flow is an absolutely necessary skill. You can’t leave home without it. You can’t! I know I’m getting excited, but the average investor, I found, does not have this basic skill. You need the basics to be successful in anything. I suggest not using a spreadsheet when you first start out. I really do. Spreadsheets cause you to lose touch with the property. Calculating on a single sheet of paper first makes the numbers your are crunching really mean something.
It’s never too late to go back to the basics. Never.
I’m currently helping 3 investors turnaround their distressed apartment building. I found a common reason and cause for their failure. The first cause is that they made a bad deal. And the very first thing they did wrong was in calculating the cash flow. This is not rocket science. In fact, it’s pretty easy, but it is often overlooked even though it’s a no-brainer.
Once you find an apartment deal to evaluate, you’ll need to find the answer to the all-important question rather quickly:
Does the property make money every month?
In evaluating any apartment deal (or any other income-producing property), there are 3 golden rules of “number-crunching” that you need to know about.
3 Golden Rules of Number Crunching
- Step 1: get the income per year
- Step 2: get the expenses per year
- Step 3: get the debt service per year
This is all you need to initially evaluate any apartment deal!!
After you do this, all that’s left is simple subtraction:
Step 1 amount
minus Step 2 amount
minus Step 3 amount
= Cash flow per year
Step 1 is to find out what the total rents are per month for each unit. Add it all up and then get the yearly amount by multiplying by 12.
Step 2 is to find out what the operating expenses are on a monthly basis. The operating expenses do not include mortgage principal or interest, but do include typical items such as taxes, insurance, utilities, repairs and maintenance, property management fee, salaries, landscaping, admin costs, advertising, and supplies.
Step 3 is to find out what the monthly mortgage would be if you bought it and then multiply that amount by 12 to get an annual mortgage amount.
You see? It’s a piece of cake, right? Know how to do this before you start using a spreadsheet of any kind. Steps 1, 2, and 3 should be engrained into your brain deeply. If you rely on spreadsheets too early, you’ll lose touch with how the property really performs. Too many have lost touch with their apartment investments and lost their cash flow. Don’t let that happen to you. Go back to the basics and build from there.