Passive Income Potential: Understanding Profits from Apartment Complexes

Apartment owners make money from rental income and price appreciation.

Owning an apartment complex can be a lucrative investment. You have the potential to make money from rental income and the property's appreciation of value. The money made from rental income depends on whether the property has a mortgage payment and what the investor's tax rate is. The property's appreciation is realized when it is sold. Adding the two together determines how much you can make.

Net Operating Income

Net operating income, or NOI, is the income an apartment complex generates after all the operating expenses are paid. It equals gross income minus total operating expenses. Gross income includes rental income from tenants and other sources, such as laundry facilities. Operating expenses include items such as maintenance, utilities, property taxes and replacement allowance, which reserves money for equipment replacement. NOI is the cash flow an owner receives before making any mortgage or income tax payments.

Before-Tax Cash Flow

If an apartment complex has a mortgage, the payment or debt service is subtracted from net operating income to determine before-tax cash flow. Debt service includes the interest and principal of the mortgage payment. The before-tax cash flow is the income generated from the property before any income tax payments are paid.

After-Tax Cash Flow

After-tax cash flow equals before-tax cash flow minus income tax. Income tax is calculated by subtracting tax-deductible items like depreciation and interest from net operating income and multiplying by the investor's tax rate. Depreciation is an annual deduction allowed by the Internal Revenue Service for physical deterioration of property. Interest is the interest portion of the mortgage payment. After-tax cash flow is the money an investor makes from an apartment complex each year after paying mortgage payments and taxes.

After-Tax Cash Flow from Sale

The after-tax cash flow from sale equals the selling price minus selling expenses, such as brokerage commissions, minus the mortgage balance, minus capital gains tax. This is the total money from the sale of the property after paying off the mortgage and taxes. The total money made from owning the apartment complex equals the sum of all the annual after-tax cash flows plus the after-tax cash flow from sale, minus the original purchase price of the property.