Always keep in mind that you will be letting other people pay your bills. Always! When I started my real estate investing, I would never consider a property unless it showed a 10% triple-net return.
That means that after paying all the fixed costs such as taxes, insurance, utilities, maintenance, management and a vacancy factor allowance, there was still a ten-percent positive net income cash flow.
Cash Flow Investing
Using an example, suppose an apartment building (could be any income type of property) has a scheduled gross income (SGI) of $15,000 per year. You arrive at this figure by adding up all the rents and any other income sources such as laundry room income as though there were no vacancies during the year.
Then actual costs of operation are subtracted including a realistic allowance for vacancies. For our example, let’s say those costs total $5000 per year (that’s a 33% overhead which is not unusual and can be much higher). Subtract the $5000 operating costs from the $15,000 SGI and you have a net operating income (NOI) of $10,000 per year.
Finally using this NOI of $10,000, the most you should be willing to pay for the apartment building would be ten times the NOI or $100,000 (see Appendix for other number-factors). When dealing with larger properties, you can frequently achieve even larger net returns. As I write, I have a property at 25% triple net and another at 40% triple net.
Example:$15,000 Scheduled Gross Income (SGI)– 5,000 Fixed Operating Expenses$10,000 Net Operating Income (NOI) (Before mortgage payment, if any) x10 NOI multiplier for a 10% net-net-net return after fixed expenses$100,000 The maximum price you would be willing to pay for this property.
What is “Triple Net”?
Think of the triple net as representing how long it will take for you to earn back the entire purchase cost of the property from just the net income it generates. At 10% per year, your tenants will repay you the total cost of the property in ten years.
At 25%, the tenants repay the total property cost in 4 years. At 40%, the property cost is recovered in 2-1/2 years. Note this is all positive cash flow. Somewhere in the late 1960s, doctors and other highly paid professionals started buying income property only for the tax deductions and because of that, they paid little or no attention to the cash flow.
As a result, many income properties started selling for values not supported by the cash flow they generated. In fact, many buyers not only had no positive cash flow, they even had to pay out of their own pockets every month just to cover the bills. Does that make any sense (cents)? Not to me!
It’s still happening today. I know several younger investors who buy brand new houses from the Builder-Developers with the idea of renting them now and selling them at a profit after three years, but which require $100- to $300 per month out-of-pocket carrying costs now in addition to the rents generated during that 3-year holding period. Remember the Greater Fool concept discussed above. Dumb is all I can say.
Where's The Mortgage?
Note that in the above cash flow analysis, I did not mention a mortgage payment. The value of a property is based on the amount of cash it generates (well not completely but close-enough for our discussion at this stage of your introduction).
How it is financed is up to the buyer. Any tax benefits become frosting on the cake because those benefits are unique to each owner. For you to be interested in buying any income property, the property must show positive NOI and must not be priced higher than a 10% triple net return would dictate. We’ll be discussing specific investment properties later using these concepts, so just accept the above as an introduction.
Note: This is just the beginning, I wrote a book, “Pssst – Wanna Be a Real Estate Millionaire?” to familiarize investors like you with all of the techniques you can use to purchase- or make money in real estate. I plan on sharing it freely and take you step-by-step through as many transactions as possible so that you will know what to expect in each instance.