As a commercial real estate investor, you need a working knowledge of complex terms like “unlevered cash flow.” Unlevered cash flow, or sometimes “unlevered free cash flow,” calculates the cash that a property generates and is available without considering its debt or equity. In contrast, “levered cash flow” considers financing expenses that are leveraged by debt.
Unlevered cash flow is one of the most critical factors involved in commercial real estate investing. Here are the three most essential things commercial real estate investors need to know about it.
1. Why It Matters
Unlevered cash flow is the cash that will be available to you as an investor. You are assessing how much cash you will be able to extract out of a particular property before considering the cost of borrowing.
Knowing the unlevered cash flow of a property can help you:
- Assess the value of a property –When you are considering making a CRE purchase, you will want to know the property’s unlevered cash flow. This is an important factor in determining its value. Because the effects of debt and equity are removed in its calculation, unlevered cash flow can help investors more accurately compare the potential associated with different properties.
- Gauge the property’s performance – You can also use unlevered cash flow to determine how well a particular property is performing. The unlevered cash flow can indicate how much money is available to pay fixed expenses, as well as what is remaining to pay you and other investors. If you do not have much-unlevered cash flow from a property, you might consider offloading the property for another that provides greater unlevered cash flow.
- Determine potential competition – Other CRE investors may be interested in a particular property when learning its unlevered cash flow. Investors care about consistent free cash flow, so expect competition when a property delivers this.
- Determine opportunities for growth –When you know how much money you can expect out of a property, you can better determine the funds you will have available to acquire more properties or expand your existing ones.
2. How It’s Calculated
While there are several different ways to calculate unlevered cash flow, the easiest is to subtract capital expenditures from your operation’s cash flow. The formula would work as follows:
Cash flow from operations – Capital expenditures = Unlevered cash flow
Here is an example of how this calculation works:
Martin purchased a property that consists of 10 office suites. He charges $2,000 a month in rent per suite. He made roof repairs that cost $10,000 and has monthly maintenance costs of $2,000 on the entire building.
$2,000(10)(12) – ($2,000)(12) – $10,000 = $206,000
This means that you would have $206,000 of cash flow available to invest or use for your operations.
To get more accurate information, you can factor in additional costs associated with your CRE, such as:
- Earnings before interest and taxes
- Increases in non-cash working capital
You can include any expenses except for those directly associated with borrowing or investing.
It is typically best to look at unlevered cash flow over years instead of one isolated year so that you can get a better idea of the potential cash flow.Top of Form
3. How It Relates to the Internal Rate of Return
Unlevered cash flow is an integral part of your internal rate of return (IRR). Your IRR measures how much your investment makes over time. This evaluation is critical when you carry a property as a short-term investment. The internal rate of return will help you determine how much return you can expect from a potential investment. You can weigh this anticipated return to the potential return of other investment opportunities. The unlevered cash flow gives you a better idea about the cash flow you can expect to receive from a given property before considering the capital structure.
Unlevered cash flow is only one crucial component in determining the internal rate of return and potential property value. Arthur Nachman is an experienced broker who can help you make such calculations to make the best investment decision based on your investment objectives and risk evaluation. He will help navigate each step of the acquisition process. Contact Arthur Nachman at (703) 864-2900 to get started.