Cash flow is one leading advantage from rental property investment and can show the potentials of the investment. Because real estate is held over relatively long period, it is important to have an overview on the revenue and expenditure of the asset over the specified period. Cash flow forecast therefore analyses the potential income and costs to be realized from operating a property. There are key elements that the forecast examines to determine the true potential of the asset.
Potential gross rent and other income
The main revenue from commercial real estate comes from rent receivable for the lease of the space. Depending on the category of the asset, rent may be daily, as in the case of hospitality facilities and apartments, monthly, annually or such period as agreed. In some cases, such as long lease retail tenancies, a lump sum payment is made at the beginning of the occupancy in addition to subsequent periodic premiums. Other income may include charges for the use of common areas and utilities including waste management and security.
Maintenance and repair Costs
Maintenance and repairs are required to keep the property in good market condition and can be a significant cost item. Depending on usage, age and even the maintenance philosophy of the asset, a careful estimation of future planned and corrective maintenance expenditures would be included in the forecast. It is important to clearly define what is covered under maintenance so that upgrades and remodeling are not misrepresented as maintenance costs.
Utilities and others
These are costs associated with common areas and facilities including external lighting, water supply, security, waste management and landscaping. Salary payments, consumables and advertising could also be included where applicable.
Taxes and Insurance
The Income Tax Act, 2015 (Act 896) outlines tax rates applicable to commercial property in Ghana. These are 8% and 15% of gross rent for residential and non-residential properties respectively. In addition to the rent tax, Local government authorities also levy property rates which depends on the value and location of the property. Insurance is another important element of the operating expenses which should also be included in the forecast.
Property management fees
Where a property is operated by a management company, a typical flat rate would be applied on the gross revenue as management fee. This takes care of administrative, supervisory and oversight work to successfully manage the property.
This section of the forecast would account for periods when the property may be vacant for various reasons. For short let apartments, hotels, and hospitality facilities, demand is expected to fall during certain periods of the year resulting in vacancies. Also, the period between the expiry of one tenancy and the beginning of another as well as time required for major maintenance activities or upgrades could also result in vacancies. Different discount rates may be applied to the cash flow.
A point of interest on the cash flow analysis is the rent adjustment that every investor wants to see, as a direct benefit of time and compensation for inflation. But the rate and frequency of increments are guided largely by market conditions. The rate you will see therefore is a conservative estimate considering prevailing and future market performance trends.
The cash flow potential of your investment property thus has many elements as outlined. One key observation; however, is that principal and interest payments are excluded from the expenses because debt servicing is not an operating cost. Whereas two properties may generate same revenue, their financing may differ and hence only considered when estimating return on investment. Cash flow analysis could help property investors examine all factors that affect income and measures to control them.