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Commercial Real Estate Cash Flow Analysis

Understanding the measures and ratios used in commercial real estate discounted cash flow analysis — explained using a real planEASe proforma income statement example with actual calculated values.

Investment Measures

These measures evaluate the overall return on a commercial real estate investment over the holding period using discounted cash flow analysis.

Internal Rate of Return (IRR) The discount rate that makes the net present value of all cash flows equal to zero. The most comprehensive measure of investment return in commercial real estate analysis.
Net Present Value (NPV) The present value of all future cash flows discounted at the investor's required rate of return, minus the initial investment. Positive NPV means the investment exceeds the required return.
Modified IRR (MIRR) A refinement of IRR that assumes reinvestment at the cost of capital rather than at the IRR itself, giving a more realistic picture of investment returns.
Monthly vs Yearly IRR How and why monthly IRR differs from annual IRR in commercial real estate analysis, and how to convert between them correctly.
Verify IRR and NPV Using Excel Step-by-step verification of planEASe monthly IRR and NPV calculations using Excel, confirming the accuracy of the discounted cash flow analysis.
Future Value The projected value of a commercial real estate investment at a future point in time, based on assumed growth rates and holding period.
Lender Yield The effective yield earned by the lender on a commercial real estate loan, taking into account points, fees, and the loan term.
Time Value of Money The foundational concept behind all discounted cash flow analysis — a dollar today is worth more than a dollar in the future due to its earning potential.

Profitability Ratios

Year-by-year ratios that measure the profitability and performance of a commercial real estate investment relative to its cost and income.

Capitalization Rate (Cap Rate) Net Operating Income divided by the property value or purchase price. The most widely used ratio in commercial real estate for comparing investment properties.
Adjusted Capitalization Rate A refinement of the cap rate that accounts for capital spending required to maintain the property, giving a more accurate picture of true yield.
Cash on Cash Return Annual before-tax cash flow divided by total cash invested. A simple measure of the cash income earned on the cash invested in a property.
Adjusted Cash on Cash Cash on Cash adjusted for capital spending, providing a more realistic measure of the actual cash return on equity invested.
Current Rate of Return Measures total return in a given year including cash flow, equity buildup, and appreciation, expressed as a percentage of current equity value.
Accounting Rate of Return Annual return based on the increase in sale value, equity buildup from loan repayment, and net operating cash flow, divided by initial equity.
Return on Investment (ROI) Total return on the full investment including the leveraged portion, measuring overall property performance independent of financing.
Gross Income Multiplier (GIM) Sale value divided by gross income. A quick rule-of-thumb ratio used to compare similar commercial properties in the same market.

Risk Ratios

Ratios that measure the financial risk and debt coverage of a commercial real estate investment.

Debt Coverage Ratio (DCR) Net Operating Income divided by total debt service. Lenders typically require a DCR of 1.25 or higher. Below 1.0 means the property cannot cover its debt payments from operating income.
Breakeven Occupancy The occupancy rate at which total income exactly covers all operating expenses and debt service. Below this level the property operates at a cash loss.
Operating Expense Ratio (OER) Total operating expenses divided by total gross income. Measures what percentage of income is consumed by operating expenses before debt service.
Loan Balance / Property Value The outstanding loan balance as a percentage of the projected property value at any given point in the holding period. Tracks equity buildup over time.
NOI / Property Value Net Operating Income divided by projected property value in each year of the holding period. Tracks how the effective cap rate changes over time.

All ratios and measures above are calculated by planEASe Software using a sample commercial real estate investment proforma. planEASe has been producing commercial real estate cash flow analysis since 1982.