Counting principal as a rental expense to estimate cash flow
Member since 2019 · 12 posts · 0 votes
Hi, I'm really interested in learning to analyze deals/properties for future investments. I've noticed in pretty much every analysis in videos and blogs, the person will deduct the entire mortgage payment (interest + principal) as a rental expense, before going on to calculate Yearly Cash Flow.
But the principal is NOT a tax-deductible expense. So why is it included as an expense in their calculations? Perfect example, see here: https://www.biggerpockets.com/...
Shouldn't the calculation actually be:
Yearly Cash Flow = ( (Rental_Income - Tax-Deductible_Rental_Expenses - Depreciation) - Taxes ) - Principal_Payments)
If I'm wrong, tell me why. I just don't get how the principal (a non-tax-deductible expense) is always included as one of the tax-deductible rental expenses in all these calculations. It makes no sense to me. What am I missing?
Your cash flow analysis should only include all that impacts your cash income, The mortgage payment does. Depreciation has nothing to do with cash income. Whether or not an expense is tax deductible has nothing to do with cash income.
Technically, it's not an expense, but a cash outflow. A few years ago, I had a mortgage where I was on the 24th year of the mortgage, 6 more years to go, and the monthly mortgage is $575 which includes over $300 in principal. This is a refinanced mortgage, I had the property so long I was done with depreciation. Tenants pays heat and water, so the cash flow is really the just rents minus the monthly payment to the bank and mowing which I include. As deductible expense does not include the principal, the reported income if higher than to cash flow by several hundred dollars a month.
I'm retired, and I have a spreadsheet each month that calculated cash inflows vs outflows so I know what leftover to invest. Some outflows are expenses and other are not. For investment purposes, I need cash outflow calculations, not expense calculations.
Your cash flow analysis should only include all that impacts your cash income, The mortgage payment does. Depreciation has nothing to do with cash income. Whether or not an expense is tax deductible has nothing to do with cash income.
Although principal is not a tax deduction you you have to include it as an expense to determine cashflow. Two very different things.
@Account Closed,
Two items to remember ...
Net Operating Income (NOI) = Operating Income - Operating Expenses
Cash flow = NOI - debt service
The loan on your property - regardless whether it is secured by a Mortgage or Deed of Trust - is amortized. In essence, that means the monthly payment amount is fixed and the amount of the payment applied to principal and interest varies as the loan balance is paid down. To track either or both components, you must build the necessary amortization calculations into your spreadsheet, etc.
The deductability of an expense does NOT offset the associated cash outflow. It only reduces the cash outflow of taxes due at the end of the tax year based on taxable income. That reduction can be adjusted based on other taxable / nontaxable income / expenses.
Long story short, you're making a huge complication out of what should be a simple calculation: Monthly Cash Flow x 12 = Yearly Cash Flow.
My $0.02 ...
Hi, I'm really interested in learning to analyze deals/properties for future investments. I've noticed in pretty much every analysis in videos and blogs, the person will deduct the entire mortgage payment (interest + principal) as a rental expense, before going on to calculate Yearly Cash Flow.
But the principal is NOT a tax-deductible expense. So why is it included as an expense in their calculations? Perfect example, see here: https://www.biggerpockets.com/...
Shouldn't the calculation actually be:
Yearly Cash Flow = ( (Rental_Income - Tax-Deductible_Rental_Expenses - Depreciation) - Taxes ) - Principal_Payments)
If I'm wrong, tell me why. I just don't get how the principal (a non-tax-deductible expense) is always included as one of the tax-deductible rental expenses in all these calculations. It makes no sense to me. What am I missing?
Not sure where you got that formula, but anyway....Positive cash flow is what you use after all payments for the business are made, to run your business, pay taxes, acquire licenses, buy toys, food,certificates of deposit, etc. It's what is in your pocket to keep and use. Expenses and depreciation (which isn't an outflow but a 'gift') applied to your tax obligations only serve to modify what you owe on those obligations.
Negative cash flow means you're making/made too many errors in running your business.
Okay thanks everyone for clearing that up. So let me add a scenario with some numbers and you tell me if they add up.
These are all hypothetical numbers by the way.
Monthly Rental Income = $2,500
Yearly Operating Income: $2,500 * 12 = $30,000
Principal = $300 average
Interest = $700 average
Property Taxes = $450
Utilities (owner pays) = $450
Insurance = $150
Repairs & Maintenance = $200
Vacancy = $125
Total Monthly Expenses: $2,075
Yearly Operating Expenses: $2,075 * 12 = $24,900
Net Operating Income = Operating Income - Operating Expenses = $30,000 - 24,900 = $5,100
Depreciation: Assume $250k mortgage, where 70% is the property, so ($250k * 0.70)/27.5 = $6,363
Taxable Income = Net Operating Income + (Yearly Principal) - Depreciation = $5,100 + $3,600 - $6,363 = $2,336
Taxes Owed (Assume 24% tax bracket) = $2,336 * 0.24 = $560
Cash Flow = Net Operating Income - Debt Service = $5,100 - $560 = $4,540/year
And let's assume we've got a $30k investment into this deal...
Return on Investment = Cash Flow / Initial Investment = ($4,540 / $30,000) * 100 = 15.13%
Does this seem correct? Sorry if it seems like I'm overthinking it, but I'd rather over-analyze than under-analyze. I need to fully understand where my money will be going before I invest tens of thousands into real estate.
Simple: cash flow does not equal taxable income. That is one advantage of RE investing. Your cash flow is always higher than what you pay taxes on.
Okay thanks everyone for clearing that up. So let me add a scenario with some numbers and you tell me if they add up.
These are all hypothetical numbers by the way.
Monthly Rental Income = $2,500
Yearly Operating Income: $2,500 * 12 = $30,000
Principal = $300 average
Interest = $700 average
Property Taxes = $450
Utilities (owner pays) = $450
Insurance = $150
Repairs & Maintenance = $200
Vacancy = $125
Total Monthly Expenses: $2,075
Yearly Operating Expenses: $2,075 * 12 = $24,900
Net Operating Income = Operating Income - Operating Expenses = $30,000 - 24,900 = $5,100
Depreciation: Assume $250k mortgage, where 70% is the property, so ($250k * 0.70)/27.5 = $6,363
Taxable Income = Net Operating Income + (Yearly Principal) - Depreciation = $5,100 + $3,600 - $6,363 = $2,336
Taxes Owed (Assume 24% tax bracket) = $2,336 * 0.24 = $560
Cash Flow = Net Operating Income - Debt Service = $5,100 - $560 = $4,540/year
And let's assume we've got a $30k investment into this deal...
Return on Investment = Cash Flow / Initial Investment = ($4,540 / $30,000) * 100 = 15.13%
Does this seem correct? Sorry if it seems like I'm overthinking it, but I'd rather over-analyze than under-analyze. I need to fully understand where my money will be going before I invest tens of thousands into real estate.
Yes ... you are WWWAAAYYY over thinking, and also confusing yourself.
Stop breaking up principal and interest, for one. It's all one payment and it all comes out of your NOI.
Depreciation does NOT come back to you as cash flow. Get that out of your numbers and leave it out. It MAY reduce your taxable income (ask your tax professional, I'm not one), but remember: it ALL becomes taxable when you sell.
You should probably get educated both on REI and how the business of real estate works. I have a source, if you need it - about 460 hours of on-line, on-demand education.
Not sure where you're getting your formulas, information, etc., but they are WWWAAAYYY off ...
David, I got my formulas from Bigger Pockets and your post above. At what point in my analysis did I go wrong? Sorry but your reply just comes off like you're trying too hard to sell me on your magic pill formula. You tell me I'm overthinking everything, but for some reason I need to watch nearly 500 hours of online courses before you can tell me why I'm miscalculating cash flow. That's ridiculous.
Besides that, people always say that the number one mistake of new investors is not knowing how to run proper analysis on a property so I think its only natural for me to make sure I got everything right rather than "kinda" understanding it then investing $50k into my first deal...
Okay thanks everyone for clearing that up. So let me add a scenario with some numbers and you tell me if they add up.
These are all hypothetical numbers by the way.
Monthly Rental Income = $2,500
Yearly Operating Income: $2,500 * 12 = $30,000
Principal = $300 average
Interest = $700 average
Property Taxes = $450
Utilities (owner pays) = $450
Insurance = $150
Repairs & Maintenance = $200
Vacancy = $125
Total Monthly Expenses: $2,075
Yearly Operating Expenses: $2,075 * 12 = $24,900
Net Operating Income = Operating Income - Operating Expenses = $30,000 - 24,900 = $5,100
Depreciation: Assume $250k mortgage, where 70% is the property, so ($250k * 0.70)/27.5 = $6,363
Taxable Income = Net Operating Income + (Yearly Principal) - Depreciation = $5,100 + $3,600 - $6,363 = $2,336
Taxes Owed (Assume 24% tax bracket) = $2,336 * 0.24 = $560
Cash Flow = Net Operating Income - Debt Service = $5,100 - $560 = $4,540/year
And let's assume we've got a $30k investment into this deal...
Return on Investment = Cash Flow / Initial Investment = ($4,540 / $30,000) * 100 = 15.13%
Does this seem correct? Sorry if it seems like I'm overthinking it, but I'd rather over-analyze than under-analyze. I need to fully understand where my money will be going before I invest tens of thousands into real estate.
The problem you got is you have the definition of operating expenses all wrong. See definition: Operating expense
Off your hypothetical list, the following are operating expenses:
Interest: $700
Property Taxes $450
Utilities: $450
Insurance: $150
Repairs: $200
Under CASH ACCOUNTING, If these are actual numbers, the total is $1,950.
The following is NOT part of operating expenses:
Principal: $300
Vacancy: $125
Principal is not an operating expense since an expense is something you paid others. Principal payment reduces the Mortgage Balance and something that goes back to you.
Vacancy is an expense only if you doing bookkeeping on an accrual basis. You make an estimate of something that "may happen in the future", expense it based on an estimate. Accrual accounting is not used normally for small property owners. If you set up a reserve for vacancies, it's again something that you paid yourself.
Then you got depreciation, where you haven't paid anything, but account for the usage of the property. The problem with real estate is it doesn't get USED, but does the opposite, increase in value, which is why they do a recapture.
I won't go further with this analysis as you appear not to have the basics of accounting, cash accounting vs accrual accounting, operating expenses vs non operating expenses vs capital expenses.
But the most basic thing is CASH FLOW is cash coming in vs cash going out. Not all cash going out like principal is operating expenses. Not all expenses like vacancy (accrual accounting) involves cash coming in or out, and principal payments which involves cash going out is not an operating expense as it comes back to you.
Okay thanks everyone for clearing that up. So let me add a scenario with some numbers and you tell me if they add up.
These are all hypothetical numbers by the way.
Monthly Rental Income = $2,500
Yearly Operating Income: $2,500 * 12 = $30,000
Principal = $300 average
Interest = $700 average
Property Taxes = $450
Utilities (owner pays) = $450
Insurance = $150
Repairs & Maintenance = $200
Vacancy = $125
Total Monthly Expenses: $2,075
Yearly Operating Expenses: $2,075 * 12 = $24,900
Net Operating Income = Operating Income - Operating Expenses = $30,000 - 24,900 = $5,100
Depreciation: Assume $250k mortgage, where 70% is the property, so ($250k * 0.70)/27.5 = $6,363
Taxable Income = Net Operating Income + (Yearly Principal) - Depreciation = $5,100 + $3,600 - $6,363 = $2,336
Taxes Owed (Assume 24% tax bracket) = $2,336 * 0.24 = $560
Cash Flow = Net Operating Income - Debt Service = $5,100 - $560 = $4,540/year
And let's assume we've got a $30k investment into this deal...
Return on Investment = Cash Flow / Initial Investment = ($4,540 / $30,000) * 100 = 15.13%
Does this seem correct? Sorry if it seems like I'm overthinking it, but I'd rather over-analyze than under-analyze. I need to fully understand where my money will be going before I invest tens of thousands into real estate.
The problem you got is you have the definition of operating expenses all wrong. See definition: Operating expense
Off your hypothetical list, the following are operating expenses:
Interest: $700
Property Taxes $450
Utilities: $450
Insurance: $150
Repairs: $200
Under CASH ACCOUNTING, If these are actual numbers, the total is $1,950.
The following is NOT part of operating expenses:
Principal: $300
Vacancy: $125
Principal is not an operating expense since an expense is something you paid others. Principal payment reduces the Mortgage Balance and something that goes back to you.
Vacancy is an expense only if you doing bookkeeping on an accrual basis. You make an estimate of something that "may happen in the future", expense it based on an estimate. Accrual accounting is not used normally for small property owners. If you set up a reserve for vacancies, it's again something that you paid yourself.
Then you got depreciation, where you haven't paid anything, but account for the usage of the property. The problem with real estate is it doesn't get USED, but does the opposite, increase in value, which is why they do a recapture.
I won't go further with this analysis as you appear not to have the basics of accounting, cash accounting vs accrual accounting, operating expenses vs non operating expenses vs capital expenses.
But the most basic thing is CASH FLOW is cash coming in vs cash going out. Not all cash going out like principal is operating expenses. Not all expenses like vacancy (accrual accounting) involves cash coming in or out, and principal payments which involves cash going out is not an operating expense as it comes back to you.
Frank, thanks for the breakdown. It seems that I have my terms mixed up which is why my original question is coming off as very confusing to others so I'll have to do some homework on that end.
https://www.fool.com/millionac...
For reference, here's an article that calculates rental income after property expenses where they don't include the mortgage principal as a tax-deductible expense. They also deduct depreciation as an "expense" even though in the future it may eventually be recaptured when the property is sold (unless you do a 1031 exchange if it makes sense to do so).
The numbers from those articles is what makes most sense to me because they differentiate between cash flow and profit. What use is positive cash flow, if after paying down the principal and taxes on taxable income you are left with very little to go back and invest with?
As a buy, rent and hold investor, I'm most interested in net profit after subtracting taxable income and paying down the principal. And even though paying down the principal means I'm building equity, what good is that if it leaves me with no hard cash at the end of the month to invest in more deals?
I also don't see how grouping together the principal payment as a rental expense doesn't actually complicate property analysis. At least to me, it's easier to calculate net profit like the author of the article does and base my analysis off that number, where I can clearly see how much of my net profit is in equity and how much is in hard cash.
What are your thoughts on the pros and cons of analyzing a rental property with the way it is done in the article?
Edit: I'd also like to add - the reason I like this breakdown analysis is that since I already own a small rental property (almost one year) and knowing that principal isn't tax deductible and I have no interest in selling the property any time in the next decade or so, then when I calculate my net profit at the end of the day I want to see exactly where my money is going/growing and the exact breakdown.
David, I got my formulas from Bigger Pockets and your post above. At what point in my analysis did I go wrong? Sorry but your reply just comes off like you're trying too hard to sell me on your magic pill formula. You tell me I'm overthinking everything, but for some reason I need to watch nearly 500 hours of online courses before you can tell me why I'm miscalculating cash flow. That's ridiculous.
Besides that, people always say that the number one mistake of new investors is not knowing how to run proper analysis on a property so I think its only natural for me to make sure I got everything right rather than "kinda" understanding it then investing $50k into my first deal...
Ok. First off, there is no "magic pill formula". Get that out of your head right now.
Second, stop trying to over complicate the numbers.
Principal and interest are a single debt service payment. It impacts your cash flow directly.
Neither depreciation nor deductibility will "write you a check every month". It is NOT an element of cash flow.
"Proper analysis" of a property is to determine it's profitability upon executing your exit strategy. If you have private investors you wish to court for financing your deals, you need to show them how their investment is protected, where their profit comes from and how the deal generates profit for them AND for you.
None of my fellow investors look at the numbers the way you're trying to. They do what I said about figuring profitability upon executing their exit strategy. The newbies take what they've learned and just do it, looking for advice as they go. The seasoned folks develop their own skills with doing it.
Now, you can keep trying to "be too smart to fall for that" or you can learn how much you need to learn, learn it, and then start being profitable.
... or, keep over-complicating things doing stuff you shouldn't while skipping over stuff you don't know that you should be doing and talk yourself out of REI altogether.
It's up to you.
Ok but I'm already investing in real estate, and in the process of saving for my next deal, so saying that I'm trying to talk myself out of REI doesn't make any sense.
And I don't get your point of trying to be "too smart". Since when is educating myself and bouncing ideas off others over-thinking things? If anything it gives me new perspectives.
I presented my analysis, and asked where I am going wrong. That's exactly what someone in a math class (or any class for that matter) does to figure out how to solve problems the right way, and how not to do it the wrong way. I gave a breakdown of my thought process and instead you shoot me down, claiming that I'm trying to be "too smart". Like what the hell is that?
Ok but I'm already investing in real estate, and in the process of saving for my next deal, so saying that I'm trying to talk myself out of REI doesn't make any sense.
And I don't get your point of trying to be "too smart". Since when is educating myself and bouncing ideas off others over-thinking things? If anything it gives me new perspectives.
I presented my analysis, and asked where I am going wrong. That's exactly what someone in a math class (or any class for that matter) does to figure out how to solve problems the right way, and how not to do it the wrong way. I gave a breakdown of my thought process and instead you shoot me down, claiming that I'm trying to be "too smart". Like what the hell is that?
If you're already investing and you're just now learning to analyze properties, you're already off the tracks and into the weeds. Note that you're "saving for my next deal" instead of learning how to find funding. Education can help you there.
Where you're going wrong is what I've said repeatedly: you're over-complicating. Education can help you there.
As I posted earlier, NOI = Operating Income - Operating Expenses and Cash flow = NOI - Debt Service. That's all there is to it.
Yes - you may need to refine your definitions, both of those categories and their elements. Education can help you there as well.
"Too smart" comes from you trying to prove you don't need education when clearly, you do.
I'm done.
@Account Closed I'd recommend as a relatively new poster on this site that you read more and argue less. There's a huge amount of useful data on this site and spending a significant amount of time sifting through it can be very beneficial. you come across as testy and easily offended and in an online forum, that doesn't get you far. (it may not be the case, but that's how it "seems" you're coming across.) You asked for advice, got some. It didn't cost anything so if you don't like it (which you apparently don't) just ignore it and keep reading.
Okay thanks everyone for clearing that up. So let me add a scenario with some numbers and you tell me if they add up.
These are all hypothetical numbers by the way.
Monthly Rental Income = $2,500
Yearly Operating Income: $2,500 * 12 = $30,000
Principal = $300 average
Interest = $700 average
Property Taxes = $450
Utilities (owner pays) = $450
Insurance = $150
Repairs & Maintenance = $200
Vacancy = $125
Total Monthly Expenses: $2,075
Yearly Operating Expenses: $2,075 * 12 = $24,900
Net Operating Income = Operating Income - Operating Expenses = $30,000 - 24,900 = $5,100
Depreciation: Assume $250k mortgage, where 70% is the property, so ($250k * 0.70)/27.5 = $6,363
Taxable Income = Net Operating Income + (Yearly Principal) - Depreciation = $5,100 + $3,600 - $6,363 = $2,336
Taxes Owed (Assume 24% tax bracket) = $2,336 * 0.24 = $560
Cash Flow = Net Operating Income - Debt Service = $5,100 - $560 = $4,540/year
And let's assume we've got a $30k investment into this deal...
Return on Investment = Cash Flow / Initial Investment = ($4,540 / $30,000) * 100 = 15.13%
Does this seem correct? Sorry if it seems like I'm overthinking it, but I'd rather over-analyze than under-analyze. I need to fully understand where my money will be going before I invest tens of thousands into real estate.
The problem you got is you have the definition of operating expenses all wrong. See definition: Operating expense
Off your hypothetical list, the following are operating expenses:
Interest: $700
Property Taxes $450
Utilities: $450
Insurance: $150
Repairs: $200
Under CASH ACCOUNTING, If these are actual numbers, the total is $1,950.
The following is NOT part of operating expenses:
Principal: $300
Vacancy: $125
Principal is not an operating expense since an expense is something you paid others. Principal payment reduces the Mortgage Balance and something that goes back to you.
Vacancy is an expense only if you doing bookkeeping on an accrual basis. You make an estimate of something that "may happen in the future", expense it based on an estimate. Accrual accounting is not used normally for small property owners. If you set up a reserve for vacancies, it's again something that you paid yourself.
Then you got depreciation, where you haven't paid anything, but account for the usage of the property. The problem with real estate is it doesn't get USED, but does the opposite, increase in value, which is why they do a recapture.
I won't go further with this analysis as you appear not to have the basics of accounting, cash accounting vs accrual accounting, operating expenses vs non operating expenses vs capital expenses.
But the most basic thing is CASH FLOW is cash coming in vs cash going out. Not all cash going out like principal is operating expenses. Not all expenses like vacancy (accrual accounting) involves cash coming in or out, and principal payments which involves cash going out is not an operating expense as it comes back to you.
Principle IS part if the operating as it is part of the debt service per month. Why would you separate the interest from the principle...the two together make up one payment.
The only formula that is less complex than calculating cash flow is cash on cash return.
CAsh flow is simple: Cash income - cash payments = cash flow
The goal is to have all of the cash payments come from the rent. That means you have positive cash flow. If there isn't enough rental income to cover all the cash going out, then you have negative cash flow.
So then I'm not allowed to question what I read? If I question something and ask someone to explain exactly what's going on in the background, I'm being testy? What a joke.
Ok but I'm already investing in real estate, and in the process of saving for my next deal, so saying that I'm trying to talk myself out of REI doesn't make any sense.
And I don't get your point of trying to be "too smart". Since when is educating myself and bouncing ideas off others over-thinking things? If anything it gives me new perspectives.
I presented my analysis, and asked where I am going wrong. That's exactly what someone in a math class (or any class for that matter) does to figure out how to solve problems the right way, and how not to do it the wrong way. I gave a breakdown of my thought process and instead you shoot me down, claiming that I'm trying to be "too smart". Like what the hell is that?
If you're already investing and you're just now learning to analyze properties, you're already off the tracks and into the weeds. Note that you're "saving for my next deal" instead of learning how to find funding. Education can help you there.
Where you're going wrong is what I've said repeatedly: you're over-complicating. Education can help you there.
As I posted earlier, NOI = Operating Income - Operating Expenses and Cash flow = NOI - Debt Service. That's all there is to it.
Yes - you may need to refine your definitions, both of those categories and their elements. Education can help you there as well.
"Too smart" comes from you trying to prove you don't need education when clearly, you do.
I'm done.
...and that just about covers it.
Ok but I'm already investing in real estate, and in the process of saving for my next deal, so saying that I'm trying to talk myself out of REI doesn't make any sense.
And I don't get your point of trying to be "too smart". Since when is educating myself and bouncing ideas off others over-thinking things? If anything it gives me new perspectives.
I presented my analysis, and asked where I am going wrong. That's exactly what someone in a math class (or any class for that matter) does to figure out how to solve problems the right way, and how not to do it the wrong way. I gave a breakdown of my thought process and instead you shoot me down, claiming that I'm trying to be "too smart". Like what the hell is that?
Except when your request to show you "where you went wrong" was answered, you dug in and basically told @David Dachtera he was wrong, and you were still right. He didn't "shoot you down", he just answered your question. You shot him down.
Okay thanks everyone for clearing that up. So let me add a scenario with some numbers and you tell me if they add up.
These are all hypothetical numbers by the way.
Monthly Rental Income = $2,500
Yearly Operating Income: $2,500 * 12 = $30,000
Principal = $300 average
Interest = $700 average
Property Taxes = $450
Utilities (owner pays) = $450
Insurance = $150
Repairs & Maintenance = $200
Vacancy = $125
Total Monthly Expenses: $2,075
Yearly Operating Expenses: $2,075 * 12 = $24,900
Net Operating Income = Operating Income - Operating Expenses = $30,000 - 24,900 = $5,100
Depreciation: Assume $250k mortgage, where 70% is the property, so ($250k * 0.70)/27.5 = $6,363
Taxable Income = Net Operating Income + (Yearly Principal) - Depreciation = $5,100 + $3,600 - $6,363 = $2,336
Taxes Owed (Assume 24% tax bracket) = $2,336 * 0.24 = $560
Cash Flow = Net Operating Income - Debt Service = $5,100 - $560 = $4,540/year
And let's assume we've got a $30k investment into this deal...
Return on Investment = Cash Flow / Initial Investment = ($4,540 / $30,000) * 100 = 15.13%
Does this seem correct? Sorry if it seems like I'm overthinking it, but I'd rather over-analyze than under-analyze. I need to fully understand where my money will be going before I invest tens of thousands into real estate.
The problem you got is you have the definition of operating expenses all wrong. See definition: Operating expense
Off your hypothetical list, the following are operating expenses:
Interest: $700
Property Taxes $450
Utilities: $450
Insurance: $150
Repairs: $200
Under CASH ACCOUNTING, If these are actual numbers, the total is $1,950.
The following is NOT part of operating expenses:
Principal: $300
Vacancy: $125
Principal is not an operating expense since an expense is something you paid others. Principal payment reduces the Mortgage Balance and something that goes back to you.
Vacancy is an expense only if you doing bookkeeping on an accrual basis. You make an estimate of something that "may happen in the future", expense it based on an estimate. Accrual accounting is not used normally for small property owners. If you set up a reserve for vacancies, it's again something that you paid yourself.
Then you got depreciation, where you haven't paid anything, but account for the usage of the property. The problem with real estate is it doesn't get USED, but does the opposite, increase in value, which is why they do a recapture.
I won't go further with this analysis as you appear not to have the basics of accounting, cash accounting vs accrual accounting, operating expenses vs non operating expenses vs capital expenses.
But the most basic thing is CASH FLOW is cash coming in vs cash going out. Not all cash going out like principal is operating expenses. Not all expenses like vacancy (accrual accounting) involves cash coming in or out, and principal payments which involves cash going out is not an operating expense as it comes back to you.
Principle IS part if the operating as it is part of the debt service per month. Why would you separate the interest from the principle...the two together make up one payment.
The only formula that is less complex than calculating cash flow is cash on cash return.
CAsh flow is simple: Cash income - cash payments = cash flow
The goal is to have all of the cash payments come from the rent. That means you have positive cash flow. If there isn't enough rental income to cover all the cash going out, then you have negative cash flow.
Joe, I understand Cash Flow = Cash Income - Cash Payments. I've also been told the reason you only care about cash flow is because you're supposed to take this cash flow and reinvest it.
The problem I'm seeing with this is you'll never be able to invest this entire cash flow amount, because assuming it's a positive number, then there is a portion of it that is taxable. Therefore, the amount of money you can actually reinvest is Cash Flow - Taxed Income.
I now understand that you don't remove the principal from the cash flow equation. But from my understanding, your Taxable Income = Cash Flow + Principal - Depreciation, right?
So then the actual amount left over to reinvest will be Cash Flow - Taxable Income.
Ignoring all the previous analysis I had (since I had my accounting terms mixed up) and just focusing on the one in this post, did I calculate anything incorrectly?
My goal with this post is to differentiate between Cash Flow, and the Post-Tax Net Profit (I don't know if there is a specific term for this, but basically just pure profit, taxes paid, etc etc).
Ok but I'm already investing in real estate, and in the process of saving for my next deal, so saying that I'm trying to talk myself out of REI doesn't make any sense.
And I don't get your point of trying to be "too smart". Since when is educating myself and bouncing ideas off others over-thinking things? If anything it gives me new perspectives.
I presented my analysis, and asked where I am going wrong. That's exactly what someone in a math class (or any class for that matter) does to figure out how to solve problems the right way, and how not to do it the wrong way. I gave a breakdown of my thought process and instead you shoot me down, claiming that I'm trying to be "too smart". Like what the hell is that?
Except when your request to show you "where you went wrong" was answered, you dug in and basically told @David Dachtera he was wrong, and you were still right. He didn't "shoot you down", he just answered your question. You shot him down.
He didn't tell me where I went wrong in my analysis. He told me I needed to buy his 460 hour online course.
"I have a source, if you need it ..."
"Education can help you ..."
"... you can learn how much you need to learn, learn it, and then start being profitable."
I told you WHAT???!!!
Read what I wrote, not what you want it to say.
What I'm reading is that I'm asking a supposedly simple question that you somehow can't answer, and if I really wanted to know the answer then I should pay you for some online course.
That's like the definition of a pyramid scheme. What next? I'll have to recruit others?
If you were actually trying to help you'd just explain your thought process by taking the hypothetical scenario I provided and breaking the numbers down yourself. Now THAT would be actually helpful.
See? I'm legitimately trying to learn here. You guys say there are tons of info on this forum. Well here I am trying to engage with the forums and y'all are pointing me elsewhere...