Why use anything but cash on cash return

Question

Hello,

Thanks ahead of time for reading and answering.  I have a full-time job with a good income and I am a buy and hold REI, using the cash flow to buy more real estate.  I will sometimes cash out refi to get cash to purchase new property.  My question is the following:  When analyzing deals, why use anything other than cash on cash return or total ROI (which assumes appreciation, equity accrual, cash flow, & taxes)?  I don't see how using IRR or any other more complicated metric is better than knowing,  for example,  if I put in $100k, I'm making at $14K on that initial investment every year.  That seems fine to me.   As long as its on par or better than the market cap rate and better than the stock market, why make it complicated and add other metrics for analysis?  I feel like I'm missing something

Mike Dymski · Answer

Your "total ROI" is fine...it's a proxy for IRR.  Many investors don't consider IRR complicated.  And it handles the timing of cash flow better than "total ROI", particularly when adding value and refinancing or selling.  The velocity of money (cash flow) is important.  "Total ROI" though is better than what many people are using.

Being "on par or better than the market cap rate and better than the stock market" is a low bar.  Active real estate investing is not worth it at those low rates of return...needs to be a larger gap (think IRR 25+% range).

Cash on cash is an acquisition metric...it's irrelevant after closing.  This is blasphemous on BP but the norm in the business world.  For some reason on BP, people separate the "money" they have in a deal from the "equity" they have in it.  @Jason Dillard said it well.

Jeremiah Mon · Answer

@Anthony Abdullah

IRR is a useful metric as it takes into account the annual COC and the equity gained after sale.

Probably the easiest to explain to passive investors compared to other complicated metrics. When you start explaining to investors MIRR and other metrics, it will just go through one ear and out the other.

People are looking to double their initial investment after 5 years (equity multiple). Keep it simple.

Russell Brazil · Answer

For high income individuals, cash on cash might not mean that much. Asset price growth tends to be a more important gage for building wealth.

Anthony Abdullah · Answer

Jim, thanks for answering and giving me another piece of good information!

Initially, isn't ROE the same as cash on cash (Cash Flow/Total initial Investment), but as time goes on, it changes because your equity increases due to loan payback?  If one were to cash out that equity, one could use that cash to do more investing, thus increasing the ROE again.  Really, does it even matter?  The cash on cash is the money that I have in the deal. The equity is increased by the tenants, so if I don't cash it out and use it, it seems as though I'm not efficient, but I'm not losing anything either.  Does that make sense?  As far as analyzing deals, it still seems like the cash on cash and/or Total ROI are allowing me to get a proper analysis of the deal.  Agree? Disagree?  Thanks so much!

Michael Noto · Answer

@Anthony Abdullah I calculate investments the same way and find this the easiest way to evaluate things. How long will it take for me to get my cash invested back? That is a question I am constantly asking myself.

Kenneth Garrett · Answer

@Anthony Abdullah

Cash on cash return is easy to calculate.  Cash in the deal versus it’s return.  Put 20% down on a 100K property and the cash flow is $500/month.  Your 20K divided by $6000/annual cash flow is 30%.  In reality with all things being equal your 100% of 20K is back in 40 months, after that your return is infinite.

ROI is more the entire investment.  You add depreciation, property tax and interest write off, mortgage pay down and appreciation if any.  A much more involved calculation.  If my money actual cash on cash return is infinite (all returned with 12 months that’s a home run.  If you follow the BRRRR strategy and done correctly your CoC is infinite no money stuck in the deal.  ROI doesn’t matter you have nothing in.

Good Luck.

Jason Dillard · Answer

@Anthony Abdullah if your equity is not from cash you invested, it's still your equity.  If your equity stays in the property, your ROE is zero.  Your equity could be zero and your cash flow would be the same.  Example:  If I own 2 houses with same NOI and debt.  Say the debt is 100k.  If the value of one house is 100k and other is 200k they will both have same cash flow let's say 5k per year.  The equity that's in both houses are making me nothing.  The 100k house earns the same as the 200k house.  So my ROE on both is zero.  Here is the rub:  The potential ROE is what most people calculate.  If you paid cash for the equity in the 200k house what is that number?  In this example it's 5%. BTW not disposing is just like rebuying!  If you trade out the equity, can you put that equity into a property that will in increase the return?  That is the question I ask myself about every property at least once per quarter.

Cash on cash is potential return before you close on property.  Your cash is in bank earning nothing.  So if you have equity stuck in a property, it's earning nothing.  We all like to keep our cash earning a return.  An elite investor treats the equity the same as cash sitting in bank.  As a matter of fact, eventually you will not ever want cash for your equity.  That's a taxable event.  We all need cash flow to cover living expenses, but once that's covered, give me equity in a better property.

Questions?

Jim Goebel · Answer

@Anthony Abdullah

Hey Anthony, at the least looking at your ROE: return on equity is useful if you are using any leverage at all.  That is really closer to your returns on invested cash, which it does sound like you're using leverage if you cash out refi after completing a project.  Read up on what that is and how to calculate!

Anthony Abdullah · Answer

Everyone, Thanks for those responses.  I will chew on all this.  I don't even know what else to ask right now.  I'll look into these concepts some more.  I have read these posts about 5 times already. I'll be back in a few. Thanks.

Jim Goebel · Answer

@Anthony Abdullah

Hey again Anthony, some of the others have posted useful responses but I feel there's a lack of grasp of the fundamentals on your part.

Basically equity functionally is your slice of what you own on a property - right?  So as a simple example if you buy with 20% down a 100k house, you have 20k in equity.  You had to bring that 20k to close.  If the property is making 10k a year in NET INCOME, then your relevant returns would be the 10k / 20k invested, or 50%.  Whereas, if you just looked at CASH ON CASH say if you bought the 100k house with cash, then you're only at 10% returns.  However, you indicated in your original post that you were looking to refinance, which means you are using leverage (debt) and your equity position is NOT 100% of the property - which means your ROE is more relevant.

I'd make sure you understand this in and out Anthony before even getting into RE, honestly.

There are follow up concepts and novelties that would be good to discuss with you as well however the first step is to do multiple of these calculations with whatever decisions you have at hand (and it'd be most relevant to think about this AFTER you've reached your intended 'steady state' of financing activity).

Why use anything but cash on cash return

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