Investor · Houston, TX · Member since 2014 · 11 posts · 2 votes
The napkin based financial analysis presented at this site is great. I am trying to understand and use it. I have just one question:
In calculation of net income why do you exclude principle and interest payments. Shouldn't at least the interest paid on mortgage be included in the expenses of the property. Otherwise doesn't estimated net income become overstated.
It's not that principle and interest payments are "excluded" just that they are considered later in the process. Net operating income is supposed to be a function of the property itself independent of debt service costs since each investor will have different financing needs and requirements.
For example, if one investor can get a 30 year, conventional mortgage with a very low interest rate, but another investor needs a commercial loan with a higher interest rate and only 25 year amortization, their debt service costs on the same property could be quite different. The final cash flow numbers will work out differently in those 2 scenarios, but the deal didn't change.
But, to address your concern, yes you do need to make sure the net operating income does cover the debt service costs and leaves acceptable cashflow.
It's not that principle and interest payments are "excluded" just that they are considered later in the process. Net operating income is supposed to be a function of the property itself independent of debt service costs since each investor will have different financing needs and requirements.
For example, if one investor can get a 30 year, conventional mortgage with a very low interest rate, but another investor needs a commercial loan with a higher interest rate and only 25 year amortization, their debt service costs on the same property could be quite different. The final cash flow numbers will work out differently in those 2 scenarios, but the deal didn't change.
But, to address your concern, yes you do need to make sure the net operating income does cover the debt service costs and leaves acceptable cashflow.
Your return on investment (ROI) is calculated using the net operating income (NOI). This will be the same regardless of financing or if you paid cash. I use this to evaluate how good the deal it. Then you factor debt service, like Brett said, because it will be different depending on your financing. The financing could turn a good deal into a great deal for cash on cash return.