Cash on Cash ROI...reality check

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Cash on Cash ROI...reality check

Samantha Soto
Investor · Indianapolis, IN · Member since 2016 · 221 posts · 134 votes

Hello everyone,

I'm new to this and working on acquiring my first deal along with my husband @Jose Soto. We are looking for properties in the Huntsville, Al area. We have primarily been looking at SFR. We have been using the rental property calculator and have been trying to make offers that get our Cash on Cash ROI to 11%. The hard thing about this is that many of the properties we are looking at are below 100k. For example, one I am looking at is listed at 87k. In order to make the numbers work for 11% I would need to offer 53k. It just seems highly unlikely to me that anyone is going to want to accept such a low offer. I even feel bad asking realtors to make these offers...like they are going to think I am wasting their time (except @Christy Harris, she has been amazing and hasn't laughed at us one...at least not to our faces!)  Anyways, I was curious to hear from the community, specifically people who have SFR's....what is the typical cash on cash returns that you get for your properties?  Do you have any with lower cash on cash ROI's that you are still happy with?  

Any words of wisdom for this newbie who is eager to buy but also wants a good deal?

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Mike Hanneman
Investor · Coeur d'Alene, ID · Member since 2016 · 551 posts · 218 votes
10y

I don't ever feel bad for making a low offer, especially if your numbers back it up. The worst that happens is you don't hear anything back. If a home has been on the market for an extended period sellers could get motiviated to sell and are just waiting for the next offer to come in. 

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  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Brent Coombs:
    Originally posted by @Luis Miramontes:

    hi guys,

    Thank you for replying! @Christy Harris,@Wes Brand, @Brent Coombs

    And yes, cap rates are generally applied for commercial properties rather than residential ones, mainly because commercial buildings are arguably ONLY about their net percentage income against their selling price. 

    But hey, why can't cap rate be useful to SFR investments too? Cheers...

    Brent the main reason cap rates are used in commercial real estate is because the NOI is generally made up of below market leases, market leases and above market leases. A residential property should not be encumbered by more than a two year lease so cap rates are a waste of time even if you had a reliable source for cap rate comps. Without a comp your number is pretty meaningless.

    0Reply
  • Christy Harris
    Investor · Huntsville, AL · Member since 2014 · 108 posts · 50 votes
    10y

    ok, so, maybe cap rate isn't the norm, but that's what we use in our spreadsheet...we have a GRM of about 75 for our properties.....won't consider unless we at least have a 100 GRM.

    0Reply
  • Wes Brand
    Investor · San Francisco, CA · Member since 2016 · 314 posts · 153 votes
    10y

    @Christy Harris Am I missing something? GRM is price / gross rents. Unless you're using that as an indicator of the area, I'd think you want it as low as possible.

    10,000 price, rents for 1000/yr

    10,000/1000=10

    10,000 price rents for 2000/yr

    10,000/2000=5

    Edit: oh, it's the at least 100 that was confusing...when read as 'at most 100' makes sense :)

    0Reply
  • Christy Harris
    Investor · Huntsville, AL · Member since 2014 · 108 posts · 50 votes
    10y

    @Wes Brand yeppers - you got it - sorry for not writing it better....one other thing - the GRM is per month not year...but you get the idea :)

    0Reply
  • Christy Harris
    Investor · Huntsville, AL · Member since 2014 · 108 posts · 50 votes
    10y

    guess I should also caveat that we buy homes needing a little work, and do about 80% of the labor. 

    0Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y
    Originally posted by @Account Closed:
    Originally posted by @Brent Coombs:
    Originally posted by @Luis Miramontes:

    hi guys,

    Thank you for replying! @Christy Harris,@Wes Brand, @Brent Coombs

    And yes, cap rates are generally applied for commercial properties rather than residential ones, mainly because commercial buildings are arguably ONLY about their net percentage income against their selling price. 

    But hey, why can't cap rate be useful to SFR investments too? Cheers...

    Brent the main reason cap rates are used in commercial real estate is because the NOI is generally made up of below market leases, market leases and above market leases. A residential property should not be encumbered by more than a two year lease so cap rates are a waste of time even if you had a reliable source for cap rate comps. Without a comp your number is pretty meaningless.

    Thanks for that explanation, differentiating commercial NOI pro formas from residential.

    Nevertheless, every residence HAS a cap rate and NOI comparable as a percentage of its purchase price - whether investors would find it useful or not! It's COMPARISONS against alternative investment opportunities that would make those figures useful to ME (but not forgetting all the other usual analysis criteria as well)...

    0Reply
  • Matt R.
    Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
    10y

    @Samantha Soto Location is the most important factor for a real estate investments profitability. This has been the case since forever and perhaps no need for a special reality check. For example, I know a person who purchased a 2+1 for 310k. That was rented for $2100. It is now worth $960k. It is located in Redondo Beach. Detroit has the highest COC and price to rent ratios on average btw. Good luck with your search!

    0Reply
  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Brent Coombs:
    Originally posted by @Account Closed:
    Originally posted by @Brent Coombs:
    Originally posted by @Luis Miramontes:

    hi guys,

    Thank you for replying! @Christy Harris,@Wes Brand, @Brent Coombs

    And yes, cap rates are generally applied for commercial properties rather than residential ones, mainly because commercial buildings are arguably ONLY about their net percentage income against their selling price. 

    But hey, why can't cap rate be useful to SFR investments too? Cheers...

    Nevertheless, every residence HAS a cap rate and NOI comparable as a percentage of its purchase price - whether investors would find it useful or not! It's COMPARISONS against alternative investment opportunities that would make those figures useful to ME (but not forgetting all the other usual analysis criteria as well)...

    OK, first where would you get a cap rate for a SFR?

    Second, let's say you were able to compile this data for two markets. If SFR's in Detroit are trading at 12% and in Honolulu at 5% What comparison can you make other than one is higher?

    1Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y
    Originally posted by @Account Closed:
    Originally posted by @Brent Coombs:
    Originally posted by @Account Closed:
    Originally posted by @Brent Coombs:
    Originally posted by @Luis Miramontes:

    hi guys,

    Thank you for replying! @Christy Harris,@Wes Brand, @Brent Coombs

    And yes, cap rates are generally applied for commercial properties rather than residential ones, mainly because commercial buildings are arguably ONLY about their net percentage income against their selling price. 

    But hey, why can't cap rate be useful to SFR investments too? Cheers...

    Nevertheless, every residence HAS a cap rate and NOI comparable as a percentage of its purchase price - whether investors would find it useful or not! It's COMPARISONS against alternative investment opportunities that would make those figures useful to ME (but not forgetting all the other usual analysis criteria as well)...

    OK, first where would you get a cap rate for a SFR?

    Second, let's say you were able to compile this data for two markets. If SFR's in Detroit are trading at 12% and in Honolulu at 5% What comparison can you make other than one is higher?

    In principle, I'm not looking at the market cap rate of particular areas , but rather, whatever (double figure) cap rate I'm looking to achieve, regardless of the areas I might be looking at.

    Put simply, I can't AFFORD to buy at 5% cap rate, even if future appreciation is (almost) certain!

    But yes, I would like to believe that my investments will eventually achieve such an abysmal 5% cap rate by the time I foist them off to the NEXT Buyers! Cheers...

    0Reply
  • Wes Brand
    Investor · San Francisco, CA · Member since 2016 · 314 posts · 153 votes
    10y

     This (I can't afford to buy at 5% cap rate) is exactly what @Account Closed means by investing for cashflow is for poor people or poor investors. You're looking at cashflow only not because it's going to give you the best return on your money over time but because you can't afford to consider anything else: a poor person. Not in a negative sense but in a you have cashflow needs sense. 

    And on the other side: 

    If you could afford to invest in the 5 cap areas but chose not to, because they didn't cashflow, that makes you a poor investor. Your investment should be dictated by your predictions of the market at this point. Declining an investment that will double your money from 1milion to 2 million in 10 years because it doesn't currently make money is a poor investment decision. On the other hand, declining it because you think the market is about to drop, or because you want to deploy your capital in a market where the rate of appreciation is higher/chance (or cost is lower)is better could be a smart move. 

    The bottom line is you need to consider the 5-cap market and evaluate if it's right for you. Not just knee-jerk 'it's 5 cap, stupid move to invest there'

    3Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y

    @Wes Brand, I believe YOU are reacting in a knee-jerk way when you say: "If you could afford to invest in the 5 cap areas but chose not to, because they didn't cashflow, that makes you a poor investor"! (But Bob will be proud of you for having that as your go-to mantra)!

    Yes, I know you sort-of hedged your bet with that "declining it because you think the market is about to drop" line, but overall, you DO seem to suggest that: if its a lousy 5 cap return, it MUST be a wise investment (even if you have to wait lots of years to get some positive cash flow)! 

    But I believe a LOT more attention should be paid to the thought: what if it DOES drop?!!!

    0Reply
  • Wes Brand
    Investor · San Francisco, CA · Member since 2016 · 314 posts · 153 votes
    10y

    @Brent Coombs What if the rental market drops and your 1200/mo rental becomes 600/mo? There's always risk in RE investing. We can play 'what if' games all day long. Investing for cashflow only without researching your market is making the same mistake as blindly buying a property because 'of course it will appreciate'. Investing for solely cashflow has the additional problem of you'll never see huge gains; your property won't go from being worth 300k to 600k in 10 years. Invest for appreciation and it might.

    Nowhere did I say that a 5cap must be a good investment because it's a 5 cap. I said if you can afford to carry it you *must* evaluate the opportunity. You can't just say '5 cap, will cost money to carry it with debt service, nope'

    The cap rate doesn't make the investment good or bad, unless you *need* the free cash flow.

    For an example of this: I'm currently evaluating a property that will cost me 7-12k per year with debt service. It's in an area that has a huge chance of appreciating, and I don't need the free cashflow. 10% appreciation means a paper networth increase of 100k. The debt is cheap; low % down(under 20) and decent interest rate with no PMI. If I put 30-40% down it'd cashflow at today's rents, but then I'm spending my own money. If rents go up in the city (unlikely in the short term, signs point to a softening market, but likely in the long term) then it cash flows easily without a bunch of my own money. If I hold it for 10 years and sell and it's gone up 300-400k, I've made a pretty great ROI. Or I refi cash out at a number that's sustainable and I get my principal out for something else. If it doesn't go up I have rents which basically cover the cost aside from the extra debt service, which is a 'deferred down payment'.

    Now, is this a good move? The answer to that depends on how strong you think the market in your investment area is. What do you think it's going to do? And it also depends on one other thing: Can you afford to carry it? If you can't the entire exercise is moot. 

    1Reply
  • Ali Boone
    Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
    10y

    @Account Closed

    Doesn't matter for you, you don't buy for cash flow.

    @Brent Coombs

    In terms of....what it means? Or specific numbers? I was just speaking about it generally in this case....a price-to-rent ratio is going to compare prices to buy properties versus the rents they can charge. It will suggest whether you can get monthly cash flow from a property or not. Price-to-rent ratios say in Indy are favorable for monthly cash flow. Price-to-rent ratios in LA are not. Meaning the purchase price is too high and the rental amount is too low (or some combination thereof) to yield the owner positive monthly cash flow.

    0Reply
  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Ali Boone:

    @Account Closed

    Doesn't matter for you, you don't buy for cash flow.

    @Brent Coombs

    In terms of....what it means? Or specific numbers? I was just speaking about it generally in this case....a price-to-rent ratio is going to compare prices to buy properties versus the rents they can charge. It will suggest whether you can get monthly cash flow from a property or not. Price-to-rent ratios say in Indy are favorable for monthly cash flow. Price-to-rent ratios in LA are not. Meaning the purchase price is too high and the rental amount is too low (or some combination thereof) to yield the owner positive monthly cash flow.

     @Ali Boone,  I invest for profit.  Only a fool or someone trying to fool someone would use a Price-to-Rent ratio as a viable metric for real estate investing.  Think about it.  Why would the market ONLY be willing to pay $100,000 for a possibility to collect $2,000 rent when in a profitable market they would pay $286,000?   What is your answer? 

    Now in my markets I look at rent growth and appreciation. Each $100,000 in appreciation provides me $700 MORE rent. Look at the high Price-to-Rent ratio markets. Generally there is no rent growth OR appreciation. If you actually collect the 2% regularly it is eaten up by inflation and CapEx.

    See how that ratio is pretty much meaningless?  So how can you tell your clients "it's all about the price-to-rent ratio?  All it does is identify low demand areas.  I guess that's why they need salesmen to try to induce people to buy likely unprofitable properties.

    1Reply
  • Samantha Soto
    OP
    Investor · Indianapolis, IN · Member since 2016 · 221 posts · 134 votes
    10y

    @Christy Harris I had never used GRM before. Another tool to add to my box :) It's more or less like the 1% rule, no?

    @Matt R. Touche!  I could buy up properties like candy in Detroit and the reality is it would be a poor investment.  I have relatives in Redondo Beach and wish my family had the foresight to buy properties there when the going was good.  Sometimes California feels like it will never be attainable to us.  It's crazy considering my husband and I are both working professionals with a six figure salary.  We are trying to keep our focus on good locations.  In the end we may end up compromising on our ROIs in favor of stability and the hopes of appreciation.  Obviously, we can't be in the red either.  Property will need to at least break even.  We are still working out the kinks.  We also don't want to bank on appreciation and then not see it come to fruition.  The first deal is scary.  I'm sure we will get better at this as we go!

    @Wes Brand, are you using the terms CAP and CoCROI interchangeably? I thought CAP rates are more for commercial real estate. What I think you are saying is that 5% is fine as long as it's a good neighborhood with anticipated appreciation. If so, I feel relieved. Things were starting to feel so black and white with the numbers that it seemed like nothing was going to work.

    I really appreciate all of your perspectives.  It is one thing to read the books and listen to the podcasts, but your perspectives and the reality of investing is what is helping me most!

    1Reply
  • Matt R.
    Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
    10y

    Right on. Let me give you some hope. The top 3 cities for total returns in Cali since 2000 are LA, SF and SD. Those are also the top 3 for the nation. (Sfrs) Some might invest for initial cash flow or COC. Some might say this is short sighted thinking. Look at the bigger picture if you can afford to. Many can and this is the biggest difference. Others might be looking to diversify or have other needs with their investments. Most I know look for profits period. Good luck!

    0Reply
  • Wes Brand
    Investor · San Francisco, CA · Member since 2016 · 314 posts · 153 votes
    10y

    @Samantha Soto They're commonly used for commercial property because you can calculate a market cap rate and compare between commercial properties. They're traded at a stable enough price that you can understand what someone means when they say "5.5cap", while with smaller units there is too much variability. In this case I was using the same language as others were and using the colloquial definition of cap rate, which can, sort of, apply to anything; assuming you're comparing across investments. I'm not talking about CoC at all -- the property I was looking at would cost me 7k/year to hold with rents; I'd be making it up in appreciation (or rent appreciation) over the long term. That said, the 7k/year is mostly just a shuffling around of money from liquid investments(cash) to illiquid ones(housing). I was calculating about 19k of equity per year, so 7k "in the red" means I'm actually gaining networth

    1Reply
  • Matt R.
    Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
    10y

    Let's examine Redondo for example.  What is less attractive about this area for long term investing today? Um nothing...it is more attractive today not less. Show me a property I lose on long term...and I will show you how you were wrong since Senor Manual Dominguez named streets after his daughters and the next street after her birth stone. IRENA =RUBY, Guadalupe = Saphire, Diamond = next etc...to the point one gal married a guy named Carson...guess what they got for a wedding present. The land for the city of Carson...hello.... @Samantha Soto

    0Reply
  • Matt R.
    Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
    10y

    And don't worry about Detroit.  The guys who know it and work it clean house too. It has been number one for flow and appreciation past two years.  But the dudes know what they are doing. Check Shea Show on youtube for a glimpse. That guy picks them up for 1500 a pop but he knows the hoods just like you know Redondo perhaps.  

    2Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y

    @Wes Brand, you asked: "What if the rental market drops and your 1200/mo rental becomes 600/mo?". Hmmm. Did rents halve, back in 2009? No? Well why would they next time?

    When property prices crash again, what will really happen? 

    In the mid-west, prices AND rents will likely keep plodding on fairly close to normal, for the simple reason that prices and rents are not already inflated! [Yes, it's a generalization].

    Most of your points are quite valid. But most of MY posts are for those who DO want/need to invest for that pesky thing called POSITIVE cash flow! Cheers...

    0Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y
    Originally posted by @Ali Boone:

    @Account Closed

    Doesn't matter for you, you don't buy for cash flow.

    @Brent Coombs

    In terms of....what it means? Or specific numbers? I was just speaking about it generally in this case....a price-to-rent ratio is going to compare prices to buy properties versus the rents they can charge. It will suggest whether you can get monthly cash flow from a property or not. Price-to-rent ratios say in Indy are favorable for monthly cash flow. Price-to-rent ratios in LA are not. Meaning the purchase price is too high and the rental amount is too low (or some combination thereof) to yield the owner positive monthly cash flow.

    Ali, I was supporting the importance you placed on price-to-rent ie. yes, specific numbers for each property being analyzed. I'm not sure why Bob wanted to make the point of suggesting to you that price-to-rent calculations are a waste. Cheers...

    0Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y

    @Account Closed, you wrote: "Each $100,000 in appreciation provides me $700 MORE rent".

    Interesting, that you already decided your cap rate will stay the same over time!

    I reckon that there are PLENTY of places where the cap rate will go DOWN in time!

    ie. appreciation, but with minimal/no rent increase.

    If that happens to you, will you succumb to the profitable notion of SELLING?

    But hang on! Doesn't your philosophy suggest: keeping it makes even more sense to you?...

    0Reply
  • Richard Dunlop
    Investor · Detroit, MI · Member since 2014 · 755 posts · 462 votes
    10y
    Originally posted by @Account Closed:
    Originally posted by @Ali Boone:

    @Account Closed

    @Brent Coombs

     @Ali Boone,  I invest for profit.  Only a fool or someone trying to fool someone would use a Price-to-Rent ratio 

    0Reply
  • Richard Dunlop
    Investor · Detroit, MI · Member since 2014 · 755 posts · 462 votes
    10y
    Originally posted by :
    0Reply
  • Richard Dunlop
    Investor · Detroit, MI · Member since 2014 · 755 posts · 462 votes
    10y
    Originally posted by @Account Closed:
    Originally posted by @Ali Boone:

    @Account Closed

    @Brent Coombs

     @Ali Boone,  I invest for profit.  Only a fool or someone trying to fool someone would use a Price-to-Rent ratio as a viable metric for real estate investing.  Think about it.  Why would the market ONLY be willing to pay $100,000 for a possibility to collect $2,000 rent when in a profitable market they would pay $286,000?   What is your answer? 

    @Bob Bowling the people you are scolding are not 1 issue investors, I speculate that they typically invest using several metrics.

    I invest in Detroit BECAUSE of the appreciation the Cash Flow is great also. I expect BOTH to be better than anywhere for the foreseeable future.

    The question I would ask (Just ONE of many) "Is why would ANYBODY invest in a market where the average weekly wage is lower than Detroit.

     Wayne is the County Detroit is in.

    Is this the only metric I should use?

    Of course not! Taking everything together I'm glad I relocated to Detroit. FROM one of your favorite markets California.

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