How to Analyze Income Producing Properties

Real Estate Investors must understand how crucial it is to project cash flow when investing in income producing property.  Making educated real estate investment decisions does ultimately depend on the property's ability to produce revenue.

The concept is straightforward. Rental properties are subject to a flow of funds whereby money comes in and goes out. When there is more money coming in than there is going out, the result is a "positive cash flow" which benefits the investor. Likewise when more money goes out that comes in the result is a "negative cash flow" that regrettably means the investor must come out of pocket in order to keep the property afloat.

Prudent real estate investors make revenue projections when evaluating an property that is cash flowing.  Knowing whether the property will produce enough cash flow to pay for itself and profit over time is important to Many Investors.  Some investors decide to invest in a property with a negative cash flow because they can get it at a discount. Many seasoned investor see this potential deal as future upside potential and make adjustments to the costs or tenants as time goes on.

Many investors use two processes to analyze income projections of property: APOD or a Proforma Income Statement.  Let take an in depth look at both of these.

An APOD (annual property operating data) is a mini income statement that is helpful to real estate investors because it give a "first-glance-look" at the property's financial condition. It reveals the income, expenses and cash flow. The issue with this type of analysis lies in the fact that an APOD offers only a projection of cash flow after the first year of ownership.  You must view this analysis to provide you with a "snapshot" of the property's cash flow that might help you to make an initial decision not necessarily to go in depth. Be sure not to rely to heavily on this process.

A proforma income statement on the other hand is a more robust way to project cash flow because it anticipates a property's financial condition beyond the first year of ownership. Moreover, a proforma income statement can account for tax shelter ,which enables the consideration of cash after taxes. This is important to investors because they can anticipate what may or may not be left over after income taxes are paid on the property's earnings. Its shortcoming, however is that the numbers are projections subject to a lot of variables that can easily be skewed.

Here's the bottom line.

You should not depend on either to provide you with enough information to make a sound investment decision.  Nonetheless, Both of these reports present cash flow projections you must consider before you purchase any rental property so you don't find yourself facing negative cash flows you didn't anticipate--a prospect no real estate investor relishes. 

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