In last week’s article, we talked about financing and how much of a down payment is required for a triple-net (NNN) lease property investment. This week, we’ll focus on how your cash flow, or return on investment (ROI), is affected by your choice to buy with all cash, utilize a 1031 exchange, or obtain a loan on the property. All three influence your monthly income, ROI, and outcome of the investment.
All-Cash Transaction & Cap Rate
The capitalization rate (cap rate) is the level of equity return on your investment and is calculated on an all-cash basis. In an absolute NNN lease property cash transaction, cap rate compares the purchase price of the property to the income (rent) it generates. Therefore, your ROI is simply the cap rate, or rent received, as there are typically no landlord expenses. When you consider the many tax advantages and incremental rent increases over a 10- to 20-year lease term, a 6% cap rate can ultimately amount to an 8-10% return.
Example: $100,000 (Net Operating Income)/$1,667,000 (Purchase Price) = 6.00% Cap Rate
Obtaining Debt & Cash-on-Cash Return
When obtaining debt to acquire a NNN investment, the goal is to secure the best financing terms available to earn the highest cash-on-cash (CoC) return. When you take out a loan, the interest rate on the debt has more to do with the CoC and long-term value of the investment, rather than the specific cap rate. Your return is the amount of cash you receive (rent minus debt service) divided by the amount of cash initially invested.
For example, if rent earned is $110,000 and your debt service is $50,000, your cash flow is $60,000. If your down payment was $1,000,000, your CoC return would be $60k/$1mm = 6% Cash-on-Cash.
Tax Advantages Add to Overall Return
For more in-depth calculations, you can assess the overall return or Internal Rate of Return (IRR). Where ROI indicates total growth start to finish, IRR identifies the annual growth rate. This calculation is less straightforward, but in the simplest of terms, you could add your principal paydown and include any tax write-offs, such as depreciation, to get to the IRR. Taking depreciation and other tax benefits on your investment could turn your pre-tax return of 6% into an 8-10% IRR. A few tax-saving techniques that can preserve capital and increase your annual IRR include:
- If you live in one of the nine states with no state income tax and purchase a commercial property here, you can boost your return.
- Utilize the 1031 exchange, which is virtually an interest-free loan from the government. This allows you to “exchange” 100% of the profits, or capital gains, from the sale of one commercial property into a similar investment property (or three) – tax-deferred – within 6 months of the sale of your old property.
- Consider cost segregation depreciation (CSD). This drastically accelerates depreciation of certain building expenses over five, seven, or 15 years, versus 27.5 or 39 years. This achieves significant tax savings on new and existing buildings and frees-up capital for immediate cash flow.
To Wrap it Up – Find Your Ideal NNN Investment with the Most Favorable ROI
As you can see, there are many ways to use your capital to invest in NNN lease properties. You can pay all cash, take out a commercial mortgage, and/or utilize a combination of tax strategies, including a 1031 exchange. Because of this varied selection, it is most effective and prudent to engage a Westwood Net Lease Buyer’s Advisor to assist in finding your ideal NNN investment with the most favorable ROI.
At no cost to you, Westwood advisors locate properties that meet your financial and lifestyle objectives, perform detailed evaluations and use financial analysis tools to determine cashflow upfront so there are no surprises and provide the closest determination of ROI for each property. Our team also works nationally with reputable mortgage brokers and industry professionals and stays with you throughout the transaction from property search to closing. Save time and invest wisely by contacting us today for a no-obligation, free consultation. 314-997-5227