Sep 23 2020by Stormi Scott

How to Successfully Navigate A Cash Flow Investment In Commercial Real Estate

When you break down the Commercial Real Estate space, you begin to realize that cash flow deals can have a very positive impact on your success if done the right way.

Cash flow is how much profit you bring in each month after collecting all of the renter's income, figuring in operating expenses, and setting aside cash reserves for future repairs. For buy-and-hold real estate investors, cash flow is the primary force used to increase passive income. But, remember, a significant part of that cash flow deal is approval from a lender. In this article, we'll breakdown three transaction details lenders typically pay attention to when financing a cash flow investment.

Net Operating Income

The lender wants to know, "what's the operating income minus expenses?" Also known as the "NOI." Sometimes, there is what we will call "hair on the transaction." Maybe the roof's got a little bit of an issue, $20,000 worth, and you think, okay, that's it! If the banker feels a different way, they'll help you by setting aside capital or escrow to close a transaction once they've started it.

Debt-Service-Coverage-Ratio

We go over DSCR and what it means in this article. In a nutshell, debt service ratio or DSCR is the operating income available to service things like interest, principal and lease payments. Today, it's a popular point of interest because it measures the entity's ability to produce enough cash to cover its debt payments.

Typically, we see a lender looking for something that covers 1.25 over the income, taking into consideration the principal interest payments you make annually. To simplify, if you have $10,000 going out the door, they want $12,500 coming in.

Appraisal Value

It's not unlikely for a developer to argue with an appraisal, especially when it comes to capitalization rate. The capitalization rate, long for cap rate, is the Net Operating Income (NOI) ÷ Purchase Price. The cap rate or some appraisal valuation is going to come onto the property. Ultimately, the banker will look at you and say, "Strength of sponsor, what's there?" They are more focused on the beginning of the transaction more than anything. Often, people don't realize that unless they're seasoned in the space.

A quick tip: To start a dialogue with a commercial banker, the key is to have the metrics. Here's how to get those numbers quickly and effectively.