“Investment is most intelligent when it is most businesslike.”
— Benjamin Graham
So where’s the real estate cash flow in your deals?
If I asked you right now to tell me in one sentence the actual cash flow on your last deal, could you do it?
Most investors can’t.
And that’s a problem.
We’ve seen some big changes in this market.
But that number is the entire point.
If you’re trying to become financially free, you have to be increasing the cash flow you’re getting every single month.
Cash flow is net operating income minus debt service.
Not rent minus mortgage.
CBRE alone surveys thousands of cap rate estimates across dozens of U.S. markets.
That’s how seriously the professionals take these numbers.
I’ve spoken with over 2,500 investors individually, and this is where most of them are guessing.
We’re going to break it down in three simple steps.
1. How to Calculate Your Real Estate Cash Flow
Cash flow is not some rough feeling of “yeah, it’s profitable.”
It’s a specific calculation.
Net operating income means rental income minus operating expenses.
Property management.
Maintenance.
Insurance.
Taxes.
Vacancy.
Then you subtract the actual debt payment.
What’s left is your real cash flow.
That’s it.
Cap rate, cash-on-cash, and NOI are three different things, and people mix them up constantly.
Here’s the one that trips up almost everyone.
Your mortgage payment never belongs in the NOI line.
Neither does depreciation.
Including either one distorts the entire calculation.
NOI measures the property.
Debt service measures your financing of that property.
Two different questions.
The mechanics here haven’t changed, but the pricing environment absolutely has.
Lenders typically want a debt service coverage ratio somewhere between 1.25 and 1.5.
Below 1.0 means the property isn’t covering its own debt.
So here’s my challenge to you.
If you can’t explain that math in one clear sentence about your own deal, you don’t actually know your cash flow.
You know a story somebody told you about your cash flow.
That’s a very different thing.
The story we tell ourselves can be wildly different from the story we’re actually living.
2. Where Real Estate Cash Flow Gets Hidden or Inflated
This is where the number gets buried.
Vacancy and turnover costs get ignored in a lot of underwriting, especially in a pitch deck designed to look attractive.
Capital expenditure reserves get skipped entirely.
The roof.
The HVAC system.
As if a property never needs anything replaced, especially an older one.
Here’s the thing.
Agency lenders require a replacement reserve escrow on multifamily loans.
That’s typically $200 to $300 per unit per year set aside before anybody sees a distribution.
Reserves are an underwriting assumption, while capex is the actual spending that eventually shows up.
The range runs higher on older properties, sometimes $500 per unit.
And a single reserve assumption can move both the loan sizing and the valuation.
Think about that.
If a lender insists on that line, why would a pitch deck leave it out?
Then there are the fees.
In syndicated deals, management and sponsor fees quietly eat into what the investor actually receives.
Sometimes more than people realize when they first sign up.
Regulators have written rules specifically around how private fund advisers disclose fees and expenses.
Every one of these gaps makes a deal look better on paper than it performs in real life.
You may have experienced this yourself.
The investors who don’t ask about them are the ones who get surprised 18 months in when distributions come in smaller than expected.
I’ve reviewed pitch decks where the projected cash-on-cash looked fantastic.
Right up until you noticed there was no line item anywhere for capital expenditures.
So ask where that line is.
If nobody can show it to you, that’s not an oversight.
That’s a red flag.
You have to plan for expenses.
You have to plan for repairs.
This is exactly where the numbers look great and inexperienced investors hurt themselves.
3. What a Genuinely Good Real Estate Cash Flow Deal Looks Like
So what does a genuinely good deal actually look like?
You look at the cap rate and the cash-on-cash return.
Then you compare them against what’s realistic for that asset class and that market.
Not against some inflated number in a marketing program.
People put together beautiful proformas.
That’s not the same as a deal.
You have to stress test it.
What happens if vacancy runs higher than expected?
National apartment vacancy has been running above eight percent.
What if costs come in higher?
What if interest rates work against you at refinance?
Operators themselves will tell you that underwriting future growth is genuinely harder right now.
Nobody gets to lean on a 2021 pro forma anymore.
If the deal only works in the best case, full occupancy, no surprises, rates staying low forever, that’s not a good cash flow deal.
That’s a bet dressed up in cash flow language.
It’s a little deceptive, honestly.
It’s saying, hey, here’s what we want this to look like.
I’d rather underwrite conservatively and be pleasantly surprised than underwrite optimistically and get blindsided.
That discipline is the difference between an investor who builds real lasting wealth and one who has a good year followed by a rough wake-up call.
So before your next deal, do the actual math yourself.
Don’t just trust the pitch or the operator.
Know your real number.
One of my biggest takeaways over the years is simply committing to understand how something works.
Buffett calls that staying inside your circle of competence.
If he doesn’t understand how it works, he doesn’t invest.
The lesson running through sixty years of his letters is the same one.
So there’s an educational piece to this for you as an investor.
Commit to learning something every single week.
Learn how this actually works so you can see what assumptions an operator is making.
And there are great deals out there that genuinely cash flow.
These days we love things like mobile home parks.
I talked with Matt Fore about finding real cash flow in car washes and mobile home parks.
There are certain types of real estate projects and developments we’re doing that are going to do very well.
But a lot of real estate deals, especially multifamily, are a real challenge right now.
So figure out what your goals are.
Find out what you actually want.
The Closing Block
Now I want to hear from you!
Can you state the cash flow on your last deal in one sentence, right now, without opening a spreadsheet?
When you last reviewed a pitch deck, did you find the capital expenditure line?
Let us know in the comments below, and let’s start a conversation.
Before you leave, make sure to check out our special report about investing. It compares the stock market to real estate; it also includes how the pandemic affects your investment future.
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