Cash flow
Cash flow is the actual money coming in and going out in connection with a property or an investment over a period. For a rental property, the cash flow is, put simply, the rent that comes in minus all the costs that go out: operations, maintenance, property tax, insurance, and interest and principal payments on loans. What is left is the owner's real surplus in kroner, and it is this figure, not the accounting result, that decides whether a property actually earns money for the owner.
Cash flow is not the same as the result or profit in the accounts. The accounts include items such as depreciation, which reduce the result without any money going out, and they allocate income and costs across periods differently from when the money actually moves. A property can show an accounting loss and still have positive cash flow, or the other way round. For a property investor, it is the cash flow that determines how much debt can be serviced and how much the owner can take out.
In valuation, cash flow is the raw material itself. A property's value can be calculated by discounting the expected future cash flows to a present value, using the required rate of return as the discount rate. The higher and more predictable the cash flow, the more the property is worth. Long, secure leases with solid tenants give a steady cash flow and therefore lower risk, while short leases, vacancy or weak tenants make the cash flow uncertain. The link between rent, costs and the required rate of return follows the same logic as yield and net effective rent.
An important distinction runs between gross and net cash flow. The gross rent is what the tenant pays, while the net figure is what is left after owner costs but before financing. If you deduct interest and principal payments, you are left with the cash flow to equity, which is what the investor actually receives. How much of the purchase is debt financed, measured by the loan-to-value ratio, therefore has a strong effect on the cash flow to equity: high gearing lifts the return when things go well, but thins out the cash flow and increases risk when interest rates rise or rent falls.
A recurring point is the difference between profitability and liquidity. A property can be profitable on paper, with good capital growth, and still have weak ongoing cash flow because much is tied up in principal payments and maintenance. Conversely, a property with stable cash flow can give secure ongoing earnings even if capital growth is modest. Vacancy is the single factor that hits hardest: if a large tenant leaves premises empty for a few months, the surplus disappears quickly, because the fixed costs continue. Tenant financial strength and lease length therefore weigh heavily when cash flow is assessed, see also net effective rent.
In Placepoint you can gather the basis for a cash flow assessment: rent levels and turnover figures in the area, the property's data and ownership details, so that you can weigh the income side against a realistic required rate of return.
From Placepoint's glossary: Cash flow
More information: Store norske leksikon: kontantstrøm
English: Cash flow (kontantstrøm; the actual cash in and out of a property over a period, net of costs and financing).
Frequently asked questions
What is cash flow for a property?
It is the actual money coming in and going out over a period: rental income minus operations, maintenance, property tax, insurance and finance costs. What is left is the owner's real surplus in kroner.
What is the difference between cash flow and the accounting result?
The result in the accounts includes items such as depreciation and period allocations that do not follow the movement of money. Cash flow shows when the money actually moves. A property can show a loss in the accounts but still have positive cash flow.
How does cash flow relate to property value?
A property's value can be calculated by discounting the expected future cash flows to a present value, where the required rate of return is the discount rate. High and predictable cash flow gives a higher value.
What is the difference between gross and net cash flow?
Gross is the rent that comes in. Net is what is left after owner costs but before financing. If you deduct interest and principal payments, you get the cash flow to equity, which is what the investor is actually left with.
How do loans affect cash flow?
The loan-to-value ratio decides how much interest and principal is deducted. High gearing can lift the return on equity, but it thins out the cash flow and increases risk if interest rates rise or rent falls.