Why does Cash-on-cash (CCR) not take into account tax benefits?

4 Replies

This has puzzled me quite a bit. 

Particularly when looking at real estate as an asset to invest in vs. alternative investments (equities, bonds, commodities, etc.), it seems silly to me to ignore total returns. Total real estate ROI should include 1) cash flow, 2) tax benefits realized each tax season in the form of real cash (non-operating items such as depreciation, mortgage interest, RE tax), 3) equity. Now, I can understand why some folks might want to leave #3 off the table since it is accounting money and not cold hard cash, but I do not fully understand why people do not include the tax benefits in cash on cash. I suppose one reason is that everyone has a different tax rate so it doesn't make sense as an objective metric that can be used across various investors. But for calculating real estate attractiveness, this absolutely needs to be part of the calc.

From doing the math, a recent model I ran showed a CCR of 7% but a CCR (incl. tax benefits) return of 17%. Not even taking into account equity. This is a huge difference and makes all the difference when comparing RE as an asset class to equities.

Am I stating the obvious or is this often not considered in public discourse on the returns on RE investment properties?

Cash on cash is what it is. That is not to say that tax consequences should not be considered, just not in this ROI calculation.

Look to IRR (internal rate of return) to include taxes and other things. So, why don't we forget about cash on cash and just at IRR? Because, cash on cash is easy and IRR is complicated. There are lots of ways to calculate return on investment. Each method serves a different purpose; hammer for nails, screwdriver for screws.

Most of the time it's enough for smaller deals to figure the cash on cash returns. You can treat the tax bennies as gravy, so there's no reason to bust your brains out and pore over spreadsheets just to make a $200k deal maybe $100 sweeter. Save that energy for the multimillion dollar deals where it's worth the effort.

In your example, does a 7% ROI meet your investing criteria? If so, do the deal. If your tax situation would net you another 10% over and above, then by all means, do the deal. I would double check my calculations, however, if I found that my tax bennies exceeded my cash of cash returns on a residential deal. Something sounds fishy. Maybe you could provide the details of your analysis. It would be interesting to review your model.

cash only. CCR reflects the ratio of cash in and out...period.

Originally posted by @Tom Mole :

Cash on cash is what it is. That is not to say that tax consequences should not be considered, just not in this ROI calculation.

Look to IRR (internal rate of return) to include taxes and other things. So, why don't we forget about cash on cash and just at IRR? Because, cash on cash is easy and IRR is complicated. There are lots of ways to calculate return on investment. Each method serves a different purpose; hammer for nails, screwdriver for screws.

Most of the time it's enough for smaller deals to figure the cash on cash returns. You can treat the tax bennies as gravy, so there's no reason to bust your brains out and pore over spreadsheets just to make a $200k deal maybe $100 sweeter. Save that energy for the multimillion dollar deals where it's worth the effort.

In your example, does a 7% ROI meet your investing criteria? If so, do the deal. If your tax situation would net you another 10% over and above, then by all means, do the deal. I would double check my calculations, however, if I found that my tax bennies exceeded my cash of cash returns on a residential deal. Something sounds fishy. Maybe you could provide the details of your analysis. It would be interesting to review your model.

Hi Tom,

I had to re-create the model from scratch quickly. Here it is with conservative assumptions (opex 60% of gross income, incl vacancy, maintenance, etc.).

The cap rate is 4.8%, the CCR is 1.1%, the CCR incl. tax benefit is 17.5%, and the IRR is 24.4%. I am probably doing something wrong but am eager to see what exactly is off. Thanks.

That is hard to see - here is full-size image link: 

http://s17.postimg.org/xnsdd8zgv/model.jpg

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