The property breakeven ratio is a useful ratio as it can provide a measure of the risk of negative cash flow of a property investment.
In particular, this measure expresses the operating cash outflows of the property, including debt service, as a percent of the property’s gross effective income. Thus, the formula for calculating the property breakeven ratio is the following:
Breakeven Ratio = (Operating Expenses + Debt Service)/Effective Gross Income
It is obvious from the above formula that the closer this ratio is to 100% the higher the risk of negative cash flow. Obviously, if the ratio is greater than 100% it indicates that the property is already experiencing a negative cash flow. On the contrary, the lower the ratio is below 100% the lower the risk the property cash flow will turn negative.
Example
Operating Expenses = 30,000
Debt Service = 40,000
Effective Gross Income = 100,000
Breakeven Ratio = (40,000 + 30,000)/100,000 = 70%
In this example the breakeven ratio is 70%. This is a measure of the risk of negative cash flow of the property as it indicates that the gross effective income needs to decline by 30% before the cash flow turns negative.
How To Calculate The Property Breakeven Ratio
1. Estimate the property’s Annual Gross Effective Income as:
Annual Rental Income from existing leases
Plus Income from additional lettings
Minus Rent losses from vacated units
2. Estimate property Annual Operating Expenses as the sum of:
Maintenance and repairs
Property management fees
Advertising expenses
Personnel expenses
Insurance expenses
Expenses for Utilities
Expenses for Supplies
Property tax payments
Other operating expenses
3. If there is a loan on the property, estimate the ANNUAL MORTGAGE PAYMENT due for the year for which the breakeven ratio is calculated
4. Estimate the sum of the annual Operating Expenses and the annual Mortgage Payment
5. Divide the result in (4) with the result from step 1, that is, the estimated annual Gross Effective Income
6. Multiply the result of step 5 with 100 in order to express the ratio as a percent
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