Posted by Dave T on March 31, 1999 at 24:41:43:
I define cash flow as Net Operating Income minus Debt Service and minus Tax Liability.
I don’t start out looking at minimum cash flow as an investment criteria all by itself. Instead I compute my debt coverage ratio, capitalization rate, and my internal rate of return for the potential investment. Of these three parameters, only internal rate of return uses cash flow in the computation.
I have thresholds for each of these parameters, and if a property “makes” the numbers, then I consider the property a potential acquisition.
Computing each of these parameters keeps me from paying too much for a property and at the same time, assures me that I can afford to keep and maintain the property.
The danger of using only cash flow as your sole investment criteria: Assume that you pick $100 per month as your cash flow requirement. A low priced property with a low-rate mortgage might easily generate $100 monthly cash flow and meet all my investment parameter thresholds as well. If that property is more expensive and the net operating income barely covers the mortgage, then $100 monthly cash flow is inadequate to take care of the unexpected emergencies or vacancies that invariably come up.