When underwriting multifamily properties, cash flow analysis is crucial for determining a deal’s viability. While annual cash flow numbers often serve as the go-to metric, relying solely on this figure can leave you blind to the short-term financial challenges that arise throughout the year.

Understanding the full cash flow picture requires more than just yearly summaries; it’s about knowing how your investment performs on a month-to-month basis.

Red Flag #5: Considering Only Annual Cash Flow

It’s easy to look at annual cash flow projections and feel confident about a deal’s potential. But focusing only on the yearly numbers can provide a false sense of security. What happens between January and December is just as important—if not more so. Month-to-month fluctuations can greatly impact your financial flexibility and the overall success of your investment.

Why This is a Red Flag

1. False Security: Positive annual cash flow might seem reassuring, but it often masks the financial instability you could experience throughout the year. Income can fluctuate from month to month due to factors like tenant turnover, market shifts, or unexpected expenses. Relying only on annual projections can leave you unprepared for these variations.
2. Reserves May Get Tapped: An annual projection could show a profitable year, but what happens if the first six months see low income or higher-than-expected expenses? Many investors have found themselves with a positive annual cash flow forecast but still had to tap into reserves during the year to cover their costs. Without considering monthly breakdowns, you may face cash shortfalls that jeopardize your operations.
3. Lack of Financial Flexibility: By focusing exclusively on annual performance, you might not fully appreciate the cash flow gaps that could arise month-to-month. This can lead to missed payments, late fees, or interest penalties, ultimately hurting your business relationships with vendors and lenders. Lack of cash flow in key months could result in financial strain that an annual projection won’t reveal.

Best Practices to Avoid This Red Flag

To avoid the dangers of focusing only on annual cash flow, there are a few key best practices that can keep your investment running smoothly throughout the year.

• Break It Down Monthly: Always project your cash flow on a monthly basis. This will help you identify when you might face shortfalls or surpluses, allowing you to plan accordingly.
• Plan for Reserves: Ensure that your reserve funds are sufficient to cover any short-term gaps in your monthly cash flow. A well-stocked reserve can make the difference between a smooth operation and a financial headache when income dips or expenses rise unexpectedly.
• Run Multiple Scenarios: Don’t just look at the best-case scenario. Consider how your cash flow might behave in moderate or worst-case situations. This approach helps you prepare for a range of possible outcomes, making your underwriting more resilient.

Conclusion: Monthly Cash Flow Matters

While annual cash flow is important, it’s only part of the picture. A healthy investment depends on how well your property performs month-to-month, not just at year-end. By breaking down your cash flow on a monthly basis, planning for reserves, and running multiple financial scenarios, you can create a more robust underwriting model. This will ensure you’re better prepared to weather the inevitable ups and downs of multifamily investing.

In real estate underwriting, the devil is in the details. By focusing on monthly cash flow, you’ll gain deeper insights into your property’s financial health and avoid the surprises that can derail even the most promising deals.