Before-tax cash flow (BTCF) is an important property investment analysis metric and represents the cash flow that the investor gets, after all operating expenses and mortgage payments due for all loans secured by the property under consideration are taken into account.
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The BTCF is used for the estimation of the return on equity (ROE), that is, the income return on the equity (own funds) invested in the property by the real estate investor. It is also necessary for the calculation of the expected before-tax total return or internal rate of return (IRR) of a property investment.
The annual BTCF can be calculated by subtracting from the annual Net Operating Income (NOI) of the property the annual mortgage payments or debt service, as loan payments are more commonly referred to in real estate investment terminology. More specifically, the formula for estimating the BTCF of a property investment is the following:
BTCF = Net Operating Income (NOI) – Debt Service
Where:
NOI = Effective Gross Income (EGI) – Operating Expenses
EGI = Gross Rental Income + Other Income + Recoveries – Vacancy and Collection Losses
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Operating expenses represent expenses that the landlord is burdened with mostly to support normal operation and functioning of the rented property. See our post on Net Operating Income (NOI) for more detail discussion of how the NOI is calculated and what recoveries are. The example in the next section clarifies how the above formulas are specifically applied to an apartment building.
A key figure that enters the before-tax cash flow calculation is the monthly or annual debt service payment. This can be calculated easily in Excel using the PMT function, if the duration of the loan, the loan amount and its interest rate are known. Actually, we provide a free spreadsheet that calculates the debt service payment for a fixed-rate loan, as well as the BTCF, if you provide the revenue and expense figures that are required for the calculation.
Example of Before-Tax Cash Flow Calculation
In order to demonstrate the application of the BTCF formula above, consider the case of an apartment building with 6 units, bought for $290,700, 80% of which was financed with a mortgage loan with a fixed interest rate of 7% and term of 20 years or 240 months over which the loan is fully amortized (fully repaid). See below the calculations for the estimation of the before-tax cash flow.
Number of Units: 6
Property Value: $290,700
Average Monthly Rent/Unit: $400
Potential Annual Rental Income (PARI): $28,800
Other Income (Annual): $0.00
Recoveries: $0.00
Vacancy and Collection Losses (% of PARI): 5.0%
Vacancy and Collection Losses Amount: $1,440.00
Effective Gross Income (EGI): $27,360.00
Operating Expenses: $4,104.00
Annual Net Operating Income: $23,256.00
Loan-to-Value Ratio: 80%
Fixed Interest Rate: 7%
Loan Term in Months: 240
Annual Debt Service: $21,636.42
Before tax cash flow: $1,619.58
The above example refers to the estimation of before-tax cash flow for only one year. However, a property investment is rarely held for one year. Typical holding periods range from three to ten years. Therefore, to properly analyze the profitability of a real estate investment over its anticipated holding period a multi-year cash flow analysis needs to be carried out using the Discounted Cash Flow (DCF) model. Check below our free before-tax cash flow calculation spreadsheet.
Free Before-Tax Cash Flow Calculation Spreadsheet
References
Mourouzi-Sivitanidou, R. (2020). Market Analysis for Real Estate 1st Edition. Ed. P. Sivitanides, London, UK: Routledge.
Sivitanides, P. 2008. Real Estate Investing for Double-Digit Returns. BookSurge Publishing.
Kolbe, P. T., & Greer, G. E. (Author), Gaylon E. Greer. (2012). Investment Analysis for Real Estate Decisions, 8th Edition. Dearborn Real Estate Education.
Geltner, M., Miller, N. G., Clayton, J., & Eichholtz, P. (2013). Commercial Real Estate Analysis and Investments (with CD-ROM). Oncource Learning
Clauretie, T. M., & Sirmans, G.S. (2009). Real Estate Finance: Theory and Practice 6th Edition. Oncource Learning.
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