Just like Roy said. Hands down the second one. For the same cash as #1, I can buy 5 #2's. That's like saying, I have $74k to invest, do I want to get $587/month return on that investment or $1,510/month?
Same cash, triple the profit! Yes, a little more work, but a little more work for triple the profit? Yes please. Easiest answer I've had since joining BP :)
There is no one right answer for all investors or situations.
No, but the beauty is I only need the right answer for this investor!
But you are making a number of assumptions in arriving at what you think is the right answer.
correct ... for the sake of this little exercise, I assumed both properties passed our screening and selection criteria.
Thank you for proving my point.
You assumed there were two properties. That was not the exercise he laid out. It was two different ways to finance the purchase and comparing the relative returns on those financing choices.
When I look at a rental property I want to see at least $400 cash flow per door on a property that is leveraged to 80% ltv. For me to own a property and all the over head that goes with it I want to see that much monthly in my pocket. My friend is more interested in cash on cash return and is happy making $100 per door as long as his cash on cash is over 20%. I guess at a certain point cash on cash becomes meaningless because the less you have in a property the higher your CoC returns.
You assumed there were two properties. That was not the exercise he laid out. It was two different ways to finance the purchase and comparing the relative returns on those financing choices.
Duncan,
Whether it is one property or two different properties is moot. If you arrive at a purchase agreement and have a choice of paying all cash or (if the property supports it) financing at 20% of the outlay, then you finance and take the other 80% of your cash and rinse and repeat. While the absolute return in the OP's example is less in scenario #2 ($302) than scenario #1 ($587), the relative return is greater.
BTW: You are still getting the same earnings in scenario #2, it just that $285/mth is being used to build equity ... for you, by your tenants.
I am going to look at both. I want cash flow because I might need cash flow and I also want to look at how long a vacancy I can have and still not have negative cash flow. In the example above both scenarios are acceptable.
Cash on cash tells me something about return. Total return = cash on cash + yearly paydown on mortgage +appreciation/equity. I like a 7.9 Cap rate and a 4% cost of money.
5 times the work for 3 times the potential profit.
Yea, but the SAME amount of cash. Who cares about the work involved. You spend all your cash on one property and then you have no cash to work with anymore :)
You assumed there were two properties. That was not the exercise he laid out. It was two different ways to finance the purchase and comparing the relative returns on those financing choices.
Duncan,
Whether it is one property or two different properties is moot. If you arrive at a purchase agreement and have a choice of paying all cash or (if the property supports it) financing at 20% of the outlay, then you finance and take the other 80% of your cash and rinse and repeat. While the absolute return in the OP's example is less in scenario #2 ($302) than scenario #1 ($587), the relative return is greater.
Wouldn't it be cool if life were really that simple? We'd have that one short little formula that would instantly take care of all our investment decisions.
There are some people for whom the right answer is to finance the purchase, for others that would be the exact WRONG thing to do.
But, hey, don't mind me. I've just been doing this through 5 Presidents, 4 major recessions, more changes to the tax code than any sane person would want to remember, 6 partnerships, 47 partners, thousands of doors, tens of thousands of renters... anyway, as I said, there is no one right answer. There are a lot of variables to every investment decision. If believe your criteria for purchases will be the same in 20 years as it is now, you are mistaken or lying to yourself.
5 times the work for 3 times the potential profit.
Yea, but the SAME amount of cash. Who cares about the work involved. You spend all your cash on one property and then you have no cash to work with anymore :)
It is potential profit.
[Note to self, completely ignore these types of discussions in the future. There is no point in telling people what they so desperately do not want to hear.]
Assuming everything else is equal, you always want the most properties for your money. Why? Take this example:
You buy 1 $100k property with $40k down. You cash flow $200/month.
Or you buy 2 $100k properties for $20k down each. You cash flow $200/month.
Are these equal? You shelled out the same amount of cash (so cash on cash return is the same either way) and you are getting the same cash flow either way so as far as your pocketbook is concerned they are, but they are NOT.
With the 2 properties you have appreciation on both homes (You own $200k worth of properties instead of $100k).
With 2 properties, you have some protection against one property being vacant.
With 2 properties, you get to raise rent twice (so to speak)
I could go on and on.
And before people berate me, yes, I understand every situation is different, but *if* you want to maximize your portfolio and get the most bang for your buck (which I easily assume is 90%+ of the investors on BP, option 2 is the only option.
That would be the worst thing to do. The best part about these forums is the differing opinions. It's very obvious we have differing opinions a lot of times but that's what makes it so great. You lay out your points, I lay out mine and then people can choose for themselves. :)
Wouldn't it be cool if life were really that simple? We'd have that one short little formula that would instantly take care of all our investment decisions.
There are some people for whom the right answer is to finance the purchase, for others that would be the exact WRONG thing to do.
But, hey, don't mind me. I've just been doing this through 5 Presidents, 4 major recessions, more changes to the tax code than any sane person would want to remember, 6 partnerships, 47 partners, thousands of doors, tens of thousands of renters... anyway, as I said, there is no one right answer. There are a lot of variables to every investment decision. If believe your criteria for purchases will be the same in 20 years as it is now, you are mistaken or lying to yourself.
Duncan:
You missed the posting above where I stated that my answer only needed to be right for me ... which intrinsically encompasses being right at the point in time the decision is made. I am not so presumptuous to assume what works for me is good, or desirable, for another.
While I may be a little newer to real estate than you, I have been building and running businesses for a comparable period ... it's not my first rodeo, but when it was, I was not afraid to make a decision ... with age and experience your decisions become more informed, more conservative ... probably better for the older you, but maybe not better for the you when you made your earlier decisions.
Now on your other markers, I might not be able to match you Prime Ministers for Presidents as we don't always change them as regularly ;)
Assuming everything else is equal, you always want the most properties for your money. Why? Take this example:
You buy 1 $100k property with $40k down. You cash flow $200/month.
Or you buy 2 $100k properties for $20k down each. You cash flow $200/month.
Are these equal? You shelled out the same amount of cash (so cash on cash return is the same either way) and you are getting the same cash flow either way so as far as your pocketbook is concerned they are, but they are NOT.
With the 2 properties you have appreciation on both homes (You own $200k worth of properties instead of $100k).
With 2 properties, you have some protection against one property being vacant.
With 2 properties, you get to raise rent twice (so to speak)
I could go on and on.
And before people berate me, yes, I understand every situation is different, but *if* you want to maximize your portfolio and get the most bang for your buck (which I easily assume is 90%+ of the investors on BP, option 2 is the only option.
Berate you? Geesh, now you sound like my ex-wife. :)
Thankfully, she wanted the leveraged properties too. ;)
How about what metric you use to evaluate a potential property? which was the essence of my original question (which wasn't expressed too clearly) since you should most always use leverage to purchase properties, unless you are looking to get money out of the market and keep it safe.
How about what metric you use to evaluate a potential property? which was the essence of my original question (which wasn't expressed too clearly) since you should most always use leverage to purchase properties, unless you are looking to get money out of the market and keep it safe.
Ahh ... this is where I believe Duncan was headed with all his probing and cajoling :)
There is no one metric we use to evaluate a property, we look at the opportunity in its entirety. We've actually developed a simulator which enables us to model discounted cash flows over several possible scenarios ... It's far more analysis than necessary, but we're software geeks and this was a way for us to become intimate with the mathematics of the analysis.
On smaller residential properties (1-4units) the {discounted} CoC over the planned hold period of the property is our lead metric - once the thresholds required for purchase & financing are met for all metrics (DC, BER, PI, etc), but this needs to be tempered against many other {not easily quantified} factors: location, state of (dis)repair; can we expand; is their a future higher use for the property.
On the commercial buildings (5+ residential or mixed use ... we have yet to venture into retail or office) the CAP rate is more meaningful, along with the CoC, but you still have all the subjective aspects as well: location; opportunity for forced appreciation/performance improvement; financing availability/terms; building age and repair; environmental, etc.
So, as Duncan was telling us yesterday ... it's not that simple ;)
5 times the work for 3 times the potential profit.
If owning 5 buildings is 5x the work for you as owning 1 building, you are doing something terribly wrong and should be focused on systemizing things and not on ROI or CoC.
As far as worrying about negative cash flow on one property for one month due to vacancy - again I don't see the point of this argument.
If you're looking at shelling out 75K to buy outright or leveraging with only 15K down, who cares if you're negative cashflow for a month because you have a mortgage payment? You've got $60K of reserves and a $300 payment. If you sock that $60K into something else (like 4 other properties) then you should be getting enough cashflow from that to cover a vacancy.
I'm strictly cash-on-cash, although I'd take a smaller CoC return on a larger property or more units. So If I'm looking at a duplex which would be $10K out of pocket and 15% ($1500/year) CoC vs. a 6-plex with $50K out of pocket and 12% ($6000/year) CoC, I'd be more interested in the 6-plex assuming I've got $50K+ to invest and those are my only two options.