What belongs in one
Start with gross potential rent, subtract a vacancy and credit-loss allowance to get gross operating income, then list every operating expense: taxes at the post-sale assessment, insurance at a current quote, management whether or not you plan to hire it, maintenance, turnover, owner-paid utilities, HOA, licensing, and administration. Subtract those for net operating income. Below that line come debt service and capital expenditures, which is where cash flow before tax finally appears. Keeping the lines in that order matters, because cap rate, debt yield, and lender sizing all key off NOI, and mixing debt into it corrupts every downstream number.
The five lines sellers shave
Vacancy set at a number the submarket has never achieved. Capital expenditures omitted entirely, which alone can swing cash flow by half. Management at zero. Property tax quoted at the seller’s long-held assessment rather than what the county will bill after the sale — in states that reassess on transfer, this is the largest silent error in real estate underwriting. And insurance at a legacy premium in a market where premiums have moved. Fix those five and most listing projections lose a meaningful share of their income.
Actuals versus projections
Ask for trailing twelve-month actuals, bank statements, tax bills, insurance declarations, and the rent roll, then reconcile them against the projection. Where the two disagree, the actuals are evidence and the projection is an argument. A gap is not automatically fatal — a genuinely mismanaged building with below-market rents is the entire thesis of a value-add purchase — but you should be able to name the specific action that closes the gap, price what it costs, and say how long it takes.
Turning it into a decision
Build three cases: the seller’s, yours, and a downside where rents hold flat, one unit sits vacant longer than planned, and insurance rises. If the deal only works in the first case, it is not a deal. If it survives the third, the offer number writes itself. Write the assumptions down beside the numbers, too, so the file can be revisited a year later against what actually happened — that feedback loop is what turns an underwriting habit into judgment, and it is the difference between an investor who has done ten deals and one who has done the same deal ten times.
Put it to work
Related terms
- Rent roll — A unit-by-unit schedule of who rents what, for how much, on what lease term, with deposits and move-in dates.
- Capex (capital expenditures) — Money spent on big-ticket components that outlast a year — roof, HVAC, water heater, windows, siding, flooring, kitchens — as opposed to routine repairs.
- Operating expense ratio — Operating expenses divided by gross operating income, shown as a percent.
- NOI (net operating income) — Annual rental income minus all operating expenses, but before mortgage payments and income taxes.
- Cash-on-cash return — Annual pre-tax cash flow divided by the total cash you actually invested — down payment, closing costs, and rehab.