Residential Income Property’s New Profit and Loss Statement
Recently, one of our visitors questioned what NetGain meant by “taking a fresh look at the business model of income property.” A fresh look means a re-examination of the business model. Income property is an operating business, and the business model for an operating business is descriptively and mathematically summarized within its profit and loss (P&L) statement. In the face of world changing events, the business model for income property has remained unchanged. Space (square feet) is leased and most of the income comes from one source: rent. Operations have become more streamlined, but remain fundamentally the same.
The world is a different place. All the signals are there. Job functions are changing. Consumer buying habits are changing. How business uses its physical space is changing. All of these factors have a profound affect on the business model of today’s income property. To deny these facts would be analogous to the person who still believes there’s a future in manufacturing telephone booths or commercial propeller driven airplanes.
Given a re-examination of the income property’s P&L statement, what are the possibilities for changing the business model?
On the income side, the average income property generates approximately 95% of its revenue from one source: rent. Yet the lessees, whether commercial or residential, spend a much larger amount of their funds on other goods and services. Why isn’t the lessor finding out what those goods and services are, and determining the financial possibilities of providing them.
On the expense side, where are the opportunities? According to the U.S. Green Building Council, buildings in the United States account for:
- 70% of electricity consumption
- 39% of energy use
- 39% of all carbon dioxide (CO2) emissions
- 40% of raw materials use
- 30% of waste output (136 million tons annually)
- 12% of potable water consumption
The global warming concept has motivated a multiplicity of methods for reducing the costs of each expense listed above.
By staying with the old business model, can the investment returns of income properties compete against alternative type investments? If not, will income property raise money efficiently for its growth and capital improvement requirements? The present business model for income property’s income, income potential, expenses, expense control, leverage, and current and future capital improvements is limiting, and ultimately it will cause difficulties in competition with the returns of alternative types of investments. Given no change in the present business model of income property, the inevitable consequences would be poorer competitive investment returns, which will reduce the ability to obtain low cost capital, and ultimately result in the deterioration of earnings.
The investment community has finally concluded that the principles underlying a successful investment for income property are the same as those for a non-real estate business. That means if you are considering an income property purchase, you need to realize that tax benefits and replacement costs take a back seat, negative cash flow and guarantees have no seat, and gross rent multipliers and price per unit are all interesting, but are not relevant for determining value. Income property’s bottom line, the net operating income (NOI), is a relationship to yield.
