• After tax cash flow is a commercial real estate performance metric that measures the amount of money left over after all of a property’s operating expenses, debt service, and taxes have been paid.
  • In a typical structure, commercial properties are held in a pass-through entity, which means that cash flow before taxes is distributed to individual investors who are each responsible for managing their own tax liability.
  • In certain circumstances, it is possible that after tax cash flow can be negative, particularly if there is a large, unexpected expense in any given year.
  • If cash flow after taxes remains negative over an extended period of time, it is possible that investors could be asked to contribute more capital to the project.  But, there are also tax benefits to this scenario.  The loss can be used to offset tax liability.

For many real estate investors, one of the most sought after benefits is a steady stream of distribution income.  But, when comparing potential opportunities, it is important to ensure that the right type of potential cash flow is being analyzed.  Of note, is the very important difference between “pre-tax cash flow” and “after tax cash flow.”

The focus of this article is the latter, after tax cash flow.  We will define what it is, how it is measured, and why it is important when evaluating potential investment opportunities.  By the end, readers will be able to clearly differentiate between the pre and after tax cash flow measurements and use this information as part of their investment evaluation process.

At First National Realty Partners, we model all of our potential investments based on the amount of pre-tax cash flow they produce.  We also encourage our investors to work with their tax professional to understand the tax impact of their investment income.  To learn more about our current investment opportunities, click here.

Typical Real Estate Investment Structure

In order to understand what after tax cash flow is, it is first necessary to understand how a typical commercial real estate investment is structured.

In the types of private equity investments that we offer, a special purpose vehicle – SPV – is formed for each investment property and used to own and operate that asset.  To raise the needed equity, shares in the SPV are sold to investors, and ownership entitles them to a proportionate share of the property’s income and profits.

This SPV is known as a “pass through entity,” which means that the property’s income and expenses flow through it and on to individual investors/owners.  The primary tax liability is at the individual level, where each investor’s tax rate / tax bracket could be different.  

To illustrate how this works, imagine that a property has $1,000 in gross income and $500 in operating expenses.  The result is $500 in “net operating income (NOI).”  From this, the property’s debt service – say $250 – is subtracted, which leaves $250 in pre-tax income.  This money would then be distributed to individual investors based on their percentage of share ownership and it will be treated as taxable income for them.   

For this reason, the pre-purchase cash flow analysis / financial model for most commercial properties stops at calculating the pre-tax cash flow number.  But, there are times where real estate investors will include the estimated tax burden to gain a more complete understanding of the property’s return potential.       

What is After Tax Cash Flow?

After-tax cash flow is a metric that represents the amount of money left over after taxes have been paid.Mathematically, it is calculated as:

After Tax Cash Flow = Net Operating Income – Debt Service – Estimated Taxes

To put this formula in context, a typical rental property proforma is summarized in the table below (NOTE:  Numbers are for illustrative purposes only):

Line Item Description Amount
Potential Rental Income $100,000
LESS: Vacancy -$10,000
Effective Rental Income $90,000
Other Income $15,000
Gross Operating Income $105,000
Property Taxes $10,000
Insurance $8,000
Maintenance $8,000
Admin $6,000
Legal $5,000
Utilities $8,000
Other Operating Expenses $12,000
Total Expenses $57,000
Net Operating Income $48,000
LESS: Debt Service $18,000
Pre-Tax Income $30,000
LESS: Estimated Taxes $13,000
After Tax Cash Flow $17,000

The key part of this proforma are the final few lines, which provides some additional context for how after tax cash flow is calculated.  In this example, it is positive.  But, this isn’t always the case.

Can After Tax Cash Flow Be Negative?

Yes.  It is possible for after tax cash flow to be negative.  If it is, there are several potential causes:

  • Falling rental income 
  • Rising operating costs (property taxes, insurance, maintenance, etc) 
  • Unexpected capital expenditures (capex) or major repairs such as roof replacement or HVAC
  • Higher than expected vacancy 

Real estate investors put a tremendous amount of work into modeling a property prior to purchasing it, but things don’t always go according to plan.  When they don’t, one of the potential outcomes is negative after-tax cash flow.  

How After Tax Cash Flow Affects Investors

For investors, there is good news and bad news about negative after-tax cash flow.

The good news is that the “loss” produced by negative after-tax cash flow can reduce the taxpayer’s income tax liability in the year it is incurred.  If the loss is big enough, it may be carried forward into future years.  However, each individual’s tax return is different and it is always a best practice to consult an accountant/tax professional to determine the exact tax impact of a loss.

The bad news depends on how big the loss is and how long it persists.  If it is relatively small and happens in just one year, it may be a non-issue.  But successive months/quarters/years of negative after tax cash flow can exhaust a property’s operating reserves, cause it to become under-capitalized, and push investment return metrics – like cash on cash return, capitalization rate (cap rate), or internal rate of return (IRR) – lower.  If this situation persists for long enough, it is possible that investors could be subject to a “capital call” which would require them to contribute more money to the deal.

Final Thoughts on After Tax Cash Flow

After tax cash flow is a commercial real estate performance metric that measures the amount of money left over after all of a property’s operating expenses, debt service, and taxes have been paid.

In a typical structure, commercial properties are held in a pass-through entity, which means that cash flow before taxes is distributed to individual investors who are each responsible for managing their own tax liability.

In certain circumstances, it is possible that after tax cash flow can be negative, particularly if there is a large, unexpected expense in any given year.

If cash flow after taxes remains negative over an extended period of time, it is possible that real estate investors could be asked to contribute more capital to the project.  But, there are also tax benefits to this scenario.  The loss can be used to offset tax liability.

Interested In Learning More?

First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.

If you are an Accredited Real Estate Investor  and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.

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