Income Analysis – Getting It Right

In our last article, we did a comparison of operating expenses vs. capital expenses. You got a good understanding of what these expenses are, where we record them and why we record them when—and just how much it matters! Today we are going to analyze all of the different ways we call and account for income. Obviously, this is an important subject because without income, you are not in business. But, in the real estate business, like most businesses, the recurring income your business generates determines the value of your business, and how much you pay your management company. Let take, for example, a ten-unit property. All units are two-bedrooms, and all units are renting for $600 per month. Let’s also say that the market rent for an apartment like this, in a building like this and in this market is $700 per month. Let’s also say that the property is 80% occupied. This means eight units are currently being rented and two are vacant. And, one unit is in the process of being evicted for nonpayment of rent. OK, now our example set up is complete. Let’s go through the different ways we account for income. Gross Market Income The first type of income we will consider is the Gross Market Income. This is the amount of income the property could generate if the property was fully rented at market rents ($700 per unit). In our example, that amount would be $700 x number of units 10 = $7,000 per month or $84,000 per year. Gross Scheduled Income Since our example property is not rented at market rents, the Gross Scheduled Income will tell us how much we could expect from our property if it was 100% occupied at the current rents. In our example, that would be $600 x 10 = $6,000 per month or $72,000 per year. Gross Potential Income The Gross Potential income is the amount of income we would collect if we were to collect 100% of the rents from all of the occupied units. In our example property, we have eight units occupied at $600 per month. That equals out to $4,800 for the month. You can already see how your income slips when you start having vacancies in your property. This is why it is so important to keep your property fully leased, and tenants retained! Vacancy Loss is the amount of money you are losing because you have units vacant. Effective Rental Income Effective Rental Income is the amount of income you actually collect. Since we have one unit in the process of being evicted, and is not paying rent, we have seven paying units. This means that our Effective Rental Income is 7 x $600 = $4,200 for the month. But our income doesn’t end there. Other Income Now we need to consider Other Income, which is non-rental income that comes in. This includes, late fees, vending income, etc. -- any income that comes into the property that is not generated by renting a unit. It’s important to note that when you analyze a property be sure to scrutinize the Other Income category and be sure all of the items are going to be recurring. Sometimes you will see a onetime Other Income such as a bonus from a cable company for using their services. The seller will want to use this in when setting price but you do not, otherwise the property will be valued at a higher price than it is worth. Utility Bill Back You may also receive Utility Bill Back. This is income that you get from tenants because you pay their utility bills (not because you want to, but because there is only one meter and you have to). But that doesn’t mean you can’t get the money from the tenants, and that’s what you do. In a future essay, I will explain exactly how you figure out the amount you can charge a tenant for a bill back. Stay tuned, you will want to know that. Total Revenues Now we are at the point where we can calculate Total Revenues. This is the culmination of everything we talked about above, and is the amount the management company will use for their commission for managing the property. Never pay a management company a flat rate. Always base their income on the amount of income that they collect for you. Obviously, they will want to collect as much as possible so they can be paid as much as possible. Loss To Lease The last thing I want to cover is Loss to Lease. Do not let this category confuse you. Opportunity is what it really is about. Loss to Lease is the difference between the amount you are charging for your rents and the amount the market is getting for the same type of apartment. In our example, market rents are going for $700 per month for the two-bedroom apartment while our apartment is getting $600 per month. The difference is $100 per month. This difference is the amount you could raise the rents after you buy the property. When you raise the rents, you increase the value of the property. We like to see a large loss to lease number. The real estate market is changing! To discover how to take advantage of this recovering market and get a 5-step proven formula to show you how create a $9,700 month to month passive income, go to Creative Success Alliance and receive a FREE copy of David Lindahl's new book "Massive Passive Income - The Real Estate Investors Guide To Prosper In A Recovering Market." Available FREE while supplies last!