Learn the key differences between Rescover's Normalized and Raw cash flow to make better investment decisions. Normalized spreads costs over time, while Raw shows immediate costs.
Introduction
If you've ever had to evaluate the performance of a real estate investment, you know that cash flow is key. Rescover offers two methods for analyzing cash flow: Normalized and Raw. Understanding the difference can help you make more informed decisions when it comes to evaluating potential investments or the health of your current portfolio.
What is Normalized Cash Flow?
Normalized Cash Flow is the standard and widely accepted approach to cash flow analysis. This mode smooths out certain metrics like vacancy and leasing commissions to give you a more balanced, long-term view of an investment's performance.
How it Works:
- Vacancy: We ask you for the average length of time tenants will stay and the time between tenants in years. This is then normalized across each year by dividing the number of vacant days by the average length of stay, multiplied by the daily rental rate.
- Leasing Commissions: We take the leasing commission rate as defined in the parameters (e.g., 100% of one month’s rent), divide it by the average length of stay, and spread that cost over each year.
What is Raw Cash Flow?
Raw Cash Flow is more of a "real-time" representation. It reflects the immediate costs and incomes without distributing them over a period. For instance, in Year 1, Raw Mode will show you the full cost of vacancy and leasing commissions. In subsequent years, these costs will be zero unless explicitly defined.
Why Use Raw Cash Flow:
- Get an understanding of the immediate, upfront costs, especially in Year 1.
- Reflects a more aggressive, yet less conventional, prediction model.
Example of Year 1 Normalized vs Raw Cash Flow:
Notice in the table above, the Gross Potential Income is the same, but in the Raw column, the vacancy loss is much higher. Similarly, there is less property management expense due to the forecast of lower income, and a higher Leasing Commission due to the full commission being paid in the first year.
Why Use One Over the Other?
- Predictability: Normalized Cash Flow aligns more with conventional analysis, making it easier to compare metrics across different properties or portfolios.
- Risk Assessment: Raw Cash Flow gives you a worst-case scenario of your upfront costs, which could be higher than expected.
How can I choose which method my analysis uses?
Most tables and metrics in Rescover operate using the Normalized data, aiming for a comprehensive 30-year property analysis. This minimizes yearly fluctuations. Attempting to foresee a specific year, say a decade from now, for vacancy or a major expense can be as impractical as assuming a fixed 5% vacancy every year for the next three decades. The key exception is the APOD table. Its default setting, the normalized mode, averages out expenses. However, switching to raw mode using the toggle will adjust this table to show cyclical income and operating expenses, as configured in your investment parameters. Please note that only the APOD table gets altered upon toggling; other metrics and tables remain unaffected.
Conclusion
Both methods have their uses, and the best choice depends on your needs and what you're comfortable with. Normalized Cash Flow is ideal for long-term planning, while Raw Cash Flow provides insights into the immediate and irregular financial obligations and performance of the property.
Remember, neither method can predict the future; they are tools to help you make the most educated decisions possible.