Cash flow after debt service

Definition and formula

Debt service is interest plus principal, in other words the loan payment. Cash flow after debt service is the amount left of the rent after all running costs and the loan payment, before tax:

The term comes from corporate finance, where banks use the debt service coverage to check whether a business can service its loans from ongoing operations. For a rental flat it is the same question on a small scale: does the rent carry the loan?

A worked example

A let condominium, Lindenstraße 14 from the Wertavo demo portfolio: bought for €268,000, cold rent €970 a month, loan payment €684.

The flat carries itself and brings in €131 a month. At the same time the remaining debt falls by €4,980 a year. Both are part of the gain, but only one of them lands in your account.

What goes into it

Cold rent

Only the net cold rent. Recoverable service charges such as heating, water or waste collection are paid in advance by the tenant and passed on by you; they are a pass-through item. If you calculate cautiously, also deduct an allowance for lost rent of 2 to 4 %, for vacancy between tenants or missed payments.

Non-recoverable costs

Everything you carry as the owner and may not pass on to the tenant, for example:

• management of the owners’ association and, where applicable, a letting agent,
• maintenance and repairs, for condominiums including the contribution to the maintenance reserve in the service charge,
• account and loan fees.

The service charge statement shows which parts are recoverable.

Interest and principal

Both are on the repayment schedule or the loan’s annual statement. With an annuity loan the payment stays the same; the interest share falls with every payment and the principal share rises. Extra repayments do not belong in ongoing cash flow; they are a decision to invest money.

Cash flow after tax

For tax, a different calculation counts. The German tax office taxes the surplus from letting: rental income minus deductible expenses. Interest, running costs and depreciation (AfA) on the building are deductible; principal is not.

In the example, depreciation is 2 % of the building share. With a €268,000 price plus €21,400 purchase costs and a building share of 80 %, that is €4,630 a year.

After tax, just under half is left, although the flat carries itself. The reason: principal is an outflow, but not deductible, so it is paid from taxed money. Conversely, negative cash flow before tax can shrink considerably after tax when high interest and depreciation produce a tax loss that lowers the tax on your other income.

The depreciation rate depends on the year of construction: 2 % for buildings completed from 1925, 2.5 % for older ones and 3 % for residential buildings completed from 2023. The contribution to the maintenance reserve only becomes deductible once the owners’ association actually spends the money.

Three returns on equity from the same flat

Return on equity relates a gain to the equity invested. Which gain is meant, many calculators do not say, yet the results lie far apart. In the example, with €68,000 of equity (price plus purchase costs minus the loan):

The first number, known as cash-on-cash, shows what actually arrives in your account. The second counts principal too, because it lowers the debt and the money is yours. The third adds value growth, which only becomes real on sale and can just as well be negative. All three are right, as long as it says which one is meant. That is why Wertavo shows what every return is made of.

Negative cash flow: what it means

Negative cash flow means you put money in every month. It is common with high financing and a low initial rent, and on its own neither good nor bad. Three questions decide:

• How much of it is principal? If €300 goes into principal and €100 is missing in cash flow, you build €300 of equity with €100 of your own money.
• What does it look like after tax? Interest and depreciation can reduce the shortfall considerably through tax.
• For how long? Rising rents and a falling interest share improve the picture over time; refinancing at a higher rate can worsen it.

Liquidity is what matters: negative cash flow has to be affordable from your income for the long term, including when a repair comes up or the flat stands empty for a few months.

How cash flow changes over the years

Cash flow is a snapshot. Over the term, three things shift:

• Interest and principal: with the same payment, the interest share falls and principal rises. Cash flow before tax stays the same, after tax it falls, because less interest is deductible.
• Rent: rent increases and new tenancies improve cash flow.
• Fixed-rate period: when it ends, the remaining debt is refinanced at a new rate. One percentage point more on €180,000 costs about €150 a month (keeping track of fixed rates).

With several flats, these changes are easy to lose sight of. Wertavo calculates cash flow per property month by month, puts every fixed-rate period on one timeline and shows when what changes. For retirement planning, cash flow counts as income; more on that in When can I retire?