Rental property income statements — often known as profit and loss (P&L) statements — are a key component of any investment property analysis.
Income statements help determine the economic feasibility of a rental property and its overall value. This article will walk you through how rental property income statements work and how to read them.
What Are Rental Property Income Statements?
Rental property income statements are key to operating a successful rental property business. It is a powerful tool for analyzing your operations, helping you focus on areas that need improvement, and identifying potential opportunities.
These statements are also required by lenders or the Ihttps://www.irs.gov/RS when applying for a mortgage, refinancing, or paying taxes.
The information provided in the statement will vary depending on whether you’re using a commercial or residential document. Residential forms are more common, as they are used to track the income and expenses related to single-family homes, multiplexes, apartment buildings, and other properties where people live.
Commercial forms are used to track income and expenses related to office buildings, warehouses, factories, and nonresidential real estate.
Both kinds of statements have a similar purpose—to provide an overview of your rental property’s financial performance during a specific period of time. However, the two types of statements differ in terms of terminology and how certain transactions are categorized.
How Rental Property Income Statements Work
A rental property income statement is a document that summarizes the revenue and expenses generated by a rental unit.
It’s similar in form and function to the income statement used in business accounting, with one major difference: The business income statement is concerned with net operating income (NOI), while the rental property income statement is concerned with net cash flow (NCF).
Net Cash Flow vs. Net Operating Income
The biggest difference between NOI and NCF is depreciation expense. Depreciation is an accounting concept that allows business owners to spread out the costs of expensive assets over time.
Even though a real estate investor may pay for a building all at once, they can still claim a depreciation expense on their taxes over 27.5 years (for residential properties), which effectively lowers their taxable income during that period.
What Should You Include in a Rental Property Income Statement?
There are two main forms of rental property income statements: personal and professional. The major difference is that a personal income statement might come from a landlord who owns one or two properties. A professional income statement shows the financial health of a much larger portfolio.
In most cases, these statements are based on monthly numbers—or annual numbers if you’re using 12 months of data. A rental property income statement should include these four items:
- Rental income
- Vacancy losses
- Net operating income
To calculate your rental income, you need to know how much you can reasonably expect to receive in rent. You also need to understand how often your property is likely to be vacant.
Next, calculate expenses related to the property itself. These include things like mortgage interest, property taxes, insurance, and maintenance costs. Some expenses may change over time—such as if you replace a water heater or invest in a new roof. Other expenses will remain the same.
If you hire a management company to take care of your property while it is occupied, those fees will be included, along with any money spent on advertising for tenants.
The net operating income (NOI) is calculated by subtracting all expenses from the rental income generated. The NOI can then be used to calculate the cap rate—or capitalization rate—which can help measure how profitable a potential investment is likely to be.
Rental property income statements are confusing for many real estate investors, because they are not always straightforward. To read them, you must understand how they are generated and the logic behind their unique formats.
At the same time, these income statements also provide an opportunity to measure your success as a landlord. You will know exactly how well you are doing with your rental properties when you review your income statement at the end of the year.
This statement will reflect great financial success if you have invested wisely in your properties.