Case Study 6: Financial and Risk Analysis in Real Estate

Part 1: Calculating Key Financial Metrics

Information for Part 1:

Calculating key financial metrics is essential for evaluating the potential return on investment and overall profitability of a real estate property.

• Cash Flow: The net amount of cash generated by the property after deducting all operating expenses and debt service.
  • Formula: Cash Flow = Rental Income – Operating Expenses – Debt Service
• Net Operating Income (NOI): The total income generated by the property after deducting all operating expenses, excluding debt service.
  • Formula: NOI = Rental Income – Operating Expenses
• Capitalization Rate (Cap Rate): The rate of return on a real estate investment property based on the income it generates.
  • Formula: Cap Rate = NOI / Property Value
• Return on Investment (ROI): The percentage return on the total investment, including both cash flow and appreciation.
  • Formula: ROI = (Cash Flow + Appreciation) / Total Investment

 \(\textbf{Formula:}\)

\[ \text{ROI} = \frac{\text{Cash Flow} + \text{Appreciation}}{\text{Total Investment}} \]

\(\textbf{Legend:}\)

\(\text{ROI}\) = Return on Investment

\(\text{Cash Flow}\) = Net income generated from the investment

\(\text{Appreciation}\) = Increase in the value of the investment

\(\text{Total Investment}\) = Initial amount invested in the property

Questions for Part 1:

1. How can Michael calculate the cash flow and NOI for the potential investment property?
   
   
2. What do the cap rate and ROI reveal about the investment’s profitability?