Definition
Cash flow analysis is the key tool for evaluating the financial viability of a rental investment.
Formula: Cash flow = Effective gross income - Operating expenses
Detailed calculation: 1. **Potential gross income**: annual rents at 100% occupancy 2. **Less vacancy and credit loss**: generally 5-10% of potential income 3. **= Effective gross income** 4. **Less operating expenses**: property taxes, insurance, maintenance (5-10% of income), management (8-12%), water/electricity common areas 5. **= Net operating income (NOI)** 6. **Less debt service**: mortgage payments (principal + interest) 7. **= After-financing cash flow**
Debt coverage ratio (DCR): NOI ÷ Debt service. Commercial lenders (5+ units) generally require a DCR > 1.2.
1% rule: a building whose total monthly rent represents ≥ 1% of purchase price generally produces positive cash flow (approximate rule of thumb).