When you're buying a home, you may be looking for a modern kitchen or a large master bath. When you're buying an investment property, you want to look for an attractive real estate income statement. You may want to invest in a specific type of property or in a certain area, but the income statement is going to tell you whether it's a good investment.
Reviewing real estate income statements
No two properties are the same, and the income and expenses can vary greatly from one to the next. A real estate income statement can tell you a lot about an individual property and how well you can expect it to perform as an investment.
The income statements will give you the information you need to calculate how much money you can make from a property. It's also useful to decide how much you should pay for the property.
Lenders will also review these income statements when deciding whether to give you a loan to purchase the property.
Knowing which statements to look at, and understanding the information they provide, is an important skill when you're deciding which property to purchase. This skill will also help you keep a closer eye on your current properties to keep them profitable.
Profit and loss statement
A real estate profit and loss statement simply breaks down the income and expenses of a property and shows you how much the investment is profiting or losing.
The first section of a profit and loss statement shows the gross income for the period. The gross income includes rental income along with any other types of income received from the property. Other forms of income may include pet fees, laundry, late fees, covered parking, etc.
The different sources of income will normally be listed separately as their own line item. Each line item is added together to show the total gross profit.
The next section of a profit and loss statement will list out all of the different operating expenses. Operating expenses are the money that was paid to operate the investment property.
Operating expenses will vary some, depending on the type of property. For instance, commercial real estate will likely have expenses you won't see for a single-family rental property.
The most common real estate operating expenses are:
- Property taxes
- Property insurance
- Management fees
- Cleaning and maintenance
- Leasing commissions
- Licenses and permits
- Professional fees
- Auto expenses
- Travel and meals
- Lawncare and snow removal
- Garbage removal
- Loan interest
There are certain expenses that you can "add back" for the purpose of understanding how much the property is actually making. The two most common expenses you can add back are depreciation and interest. These are additional expenses the Internal Revenue Service (IRS) allows you to deduct on your tax returns.
Depreciation can be added back because it's not an annual expense. Depreciation just allows you to reduce your income tax liability.
Loan interest is an expense that will be different for each investor. To accurately analyze a property, you'll want to add back the current interest expense, then do your calculations based on what the interest will be on your loan.
Net operating income
The last section of a profit and loss statement will show the net operating income (NOI). The NOI is the profit, or loss, on the property. The NOI is the number you'll use for your calculations when analyzing an income property.
You'll divide the net operating income by the purchase price to find out what the capitalization rate is. You can also divide the net operating income by the cap rate you want to figure out what the right purchase price for you would be.
The net operating income is also an important number for lenders when they're deciding whether to give you a loan on the property. The lender will use the NOI to calculate the debt service coverage ratio (DSCR).
The DSCR basically tells them whether the property nets enough income to be able to make the loan payments. They usually want to see that the property makes more than it needs to in order to make the loan payments. The lender wants to see that you can make the loan payments as well as cover any unexpected costs or handle any vacancies.
To calculate a DSCR, you divide the NOI by the annual debt service. The annual debt service is the total amount you will pay in a year on your loan. If your loan payments are $1,000 per month, your annual debt service would be $12,000.
For example, if the NOI is $15,000 and your annual debt service is $12,000:
$15,000 / $12,000 = 1.25. Your debt service coverage ratio would be 1.25.
You'll also use the NOI to figure out what your net cash flow will be. Subtracting your annual debt service from the net operating income will tell you how much money you'll actually see at the end of the day.