REAL ESTATE INVESTMENT CASH-FLOW TUTORIAL

THIS IS AN EXAMPLE OF ANALYSIS OF AN INVESTMENT FOR CASH FLOW AS WELL AS APPRECIATION AND ROI (RETURN ON INVESTMENT). PLEASE CONSULT YOUR TAX ADVISOR TO ASSURE THAT YOUR TREATMENT WILL BE THE SAME.

THE SPREADSHEET TO DO THESE CALCULATIONS AUTOMATICALLY FOR YOU IS AVAILABLE FROM OUR WEBSITE.

Copyright 2002 Ken Radtke

 
TABLE OF CONTENTS. CLICK TO GO TO A SECTION:
  1. INVESTMENT PARAMETERS FOR THE PROPERTY
   2. ANNUAL CASH FLOW
   3. LONG TERM APPRECIATION AND TAXES DUE ON SALE
   4. BOTTOM LINE SUMMARY OF GAINS AND ROI
1. INVESTMENT PARAMETERS FOR THE PROPERTY
 $119,900 Purchase Price of investment property
20% Land Allocation = portion of value which won't be depreciated
   $95,920 1st Loan Annual Interest =  $6,114.90
6.375% Interest Rate of 1st Loan

$0

 2nd Loan, if any. Annual Interest (on 2nd) = $ 0 
0 Rate of 2nd Loan Total Annual Interest (on 2nd) = $  6,114.90
20% Down Payment we will apply =  $  23,980.00
3% Closing Cost estimate = $   3,597.00
$975 Monthly rent we will take in
5% Annual vacancy allowance
10% Annual Property Appreciation Rate expected of the property
5 Holding Period we expect before we sell property (years)
7% Projected Cost to sell the property (% of sale price)
ANNUAL OPERATING EXPENSES
$677 Property Taxes
$250 Insurance
$0 Utilities if we will pay them
1536 Maintenance (Example has HOA dues @ 128/month)
0 Other 1:
310 Other 2: home warranty to cover repairs and appliances
250 Other 3: cost to get clients
TOTAL =  $3,023.00 per year op. expenses
30% Investor's Tax Bracket % (incremental fed + state)
4.0% Investor's Pre-Tax Investment Rate

2.80%

 x (100% - tax rate) = Investors After Tax Investment Rate
IRS determined constants. Consult your tax advisor!
25% Tax Rate for depreciation portion of recovery
20% Capital Gain tax rate  (for time period you plan to hold property)
27.5 Cost Recovery Period for Improvements (years)
Source: Building Wealth through Residential Real Estate Investments
2. ANNUAL CASH-FLOW (USING PARAMETERS ABOVE)
    $119,900 Purchase price

         x 80%

 x % Improvement allocation (100% - Land Allocation)
 =   $95,920 Improvement Value (amount which can be depreciated)
Determine Initial Investment:
   $23,980 Down Payment
 + $3,597 plus Closing Cost
  $27,577 = Initial Investment of cash that we will make to aquire the property
Calculate Gross Scheduled Income
      $975 monthly rent
     x    12 x 12
 $11,700 = Gross Scheduled Income (per year, ignoring vacancy)
Calculate Cash Flow Before Taxes:
   $11,700 Gross Scheduled Income
     - $585 LESS vacancy allowance
  $11,115 = GROSS OPERATING INCOME (per year, with vacancy)
  - $3,023 LESS Total Operating Expenses
    $ 8,092 = NOI (NET OPERATING INCOME) per year
   - $6,115 LESS Annual Interest Payments
     $1,977 = (CFBT) CASH FLOW BEFORE TAXES
Annual Cost Recovery:
 $95,920 Improvement Value
     / 27.5 Divided by Cost recovery Period of 27.5 years
 $3,488  = Annual Cost Recovery (depreciation for your tax form)
Cash Flow After Taxes

    $1,977 Cash Flow Before Taxes, from above
  - $3,488 LESS Annual Cost Recovery:
 $(1,511) = TAXABLE INCOME OR LOSS. Here its a loss so it will offset income and allow you to pay less tax (consult your tax advisor)

    x   30%

 TIMES Investors Tax Bracket
     $(453) = TAX SAVINGS OR LIABILITY: Here it is negative so this is a tax savings. There will be no taxes due, and you may be able to offset other income with this loss either this year or next year (consult your tax advisor)
  $1,977 Cash Flow Before Taxes, from above
+  $453 Plus benefit or detriment of tax savings or liability. This is the negated Tax savings or liability from above.
 $2,430 = ANNUAL CASH FLOW AFTER TAXES. This is the bottom line on cash flow. In this example it is positive, so you are taking in this cash per year.
3. LONG TERM APPRECIATION AND TAX DUE ON SALE
Your property value will appreciate in a number of years, and if you sell it then you will have taxes due. Don't get hung up on the tax calculations. The point is that you will payoff the bank, payoff the taxes, and have money left in your pocket. If you roll the investment by 1031 exchange, there will be no taxes due.
 $ 119,900 Original Purchase Price (PV or Present Value on your financial calculator)
10% Expected Annual Appreciate Rate ("I" )
5 Holding Period in years, entered above("n" or number of annual periods)
 $193,100 = PROJECTED SALES PRICE ("FV" after solving for Future Value) = PV * (1+I)**n. This is what it will be worth in 5 years in this example.
 - $13,517 LESS Projected Cost of Sale at 7%:
Calculate adjusted basis of your investment
 $119,900 Purchase price
 + $3,597 PLUS: Original closing Costs
LESS Total Recovery:
 $   3,488.00 Annual Recovery
5 TIMES Holding Period
 -  $17,440    <--Total Cost recovery Taken on your taxes in the prior years
  - $106,057 LESS the Adjusted Basis  $106,057 Adjusted Basis
 $73,526 TOTAL TAXABLE GAIN ON SALE
To Calculate Recapture Tax (because depreciated value is taxed at different rate then the capital gains is taxed at:
 $ 17,440 Recapture Total Cost Recovery Taken

     x  25%

 TIMES Tax Rate to be charged on the depreciation portion)
 $ 4,360 = Tax Due from Recapture of Cost Recovery
To Calculate the Balance of Capital Gains Tax
    $73,526 Total Taxable Gain on Sale
  - $17,440 LESS: Total cost of Recovery Taken (Recapture)
    $56,086 = balance of Capital Gain

    x   20%

 TIMES Long-Term Capital Gains Tax Rate
 $11,217 =Balance of Capital Gains Tax Due from Sale
 + $ 4,360 ADD Tax Due from Recapture of Cost Recovery
 $15,577 = TOTAL TAX DUE ON SALE
  4. BOTTOM LINE SUMMARY OF GAINS AND ROI
1st component is money in your pocket from appreciation of value of the property at the future date in which you sell it.
    $193,100 Projected Sales Price in the future, 5 years in this example
  -  $13,517 LESS Projected cost of sale, including all sales and marketing costs
  -  $95,920 LESS Mortgage Balance Due to the bank
  -  $15,577 LESS Tax Due on sale as calculated above (if 1031 exchange then no tax)
     $68,085 = AFTER-TAX PROCEEDS FROM SALE. This is after-tax return in your pocket
2nd component is the total gain you had in your pocket each year while you rented the property out.
     $ 2,430 ANNUAL CASH FLOW AFTER TAX (PMT)

        2.80%

 Investor's After-Tax Rate of Return (I) = interest received or paid on the cash that you took in during the rent periods and you chose to reinvest at this rate

                5

Holding Period (n) in years, years you held the property and collected rent

     $12,851

 = AMOUNT ACCUMULATED from rental income (Solve for FV on your financial calculator).
Finally, figure out the rate of return for this investment.
$80,937 Total Future Wealth  (FV). Add the two amounts above, the after-tax sale proceeds plus the amount accumulated from rental income. This is what you walked away with.
      $27,577 Initial Investment (PV). This is your original down payment plus all costs of buying, so this is what you put in to start.
5 Holding Period (n). The number of years you had this money invested.
24.03% = AFTER TAX RATE OF RETURN / YIELD (Solve for I). This is a IRR rate of return calculation on your financial calculator. This is the annualized return rate you got back from your investment. TIP: a higher down payment increases equity in your investment, but it decreases leverage and ROI.