DEBATE: Cash Flow vs Cash on Cash return
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Roy N.Pro Member
Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votesHands down the second one ... or should I say the second "five"? For the same cash outlay, I would see cash-flow of $1510/month.
49 Replies
Originally posted by @Shawn M.:
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.Sorry, no magic formula here. It's about the deal as a whole and what I'm trying to accomplish. For ME, I'm trying to build my portfolio as fast as possible, so my metrics look like this:
I am trying to get a property for as little down while still getting Cash on Cash Return over 20% and $150+/month for my sub-$100k properties. I have some other less important metrics, but that's my driver right now. When I move to multifamily my "goals" for each property will vary.
So....in the essence of your original question, I would have to go with cash on cash return. Again there is more to it but you're looking for a specific answer to your specific question. In most cases, the less money you put into it, the higher your ConC will be and the more money you'll have to do it again. With that being said, there is a point where ConC becomes pointless. I am not willing to purchase a property where the cash flow is $50/month regardless of how good the ConC looks. I have several metrics that I look at and have minimum's for each.
My process is this. I estimate everything and put it into a spreadsheet. I'm "somewhat" conservative. I've bought 5 properties so far and my actual numbers always turned out better than what I originally projected so I feel very comfortable with my process at this point. I spend 15 minutes evaluating the output. If my goals aren't met, I move on. I will not spend more than 15 minutes on a property unless the conservative numbers meet my minimums.
- 12yJohn HornerPro MemberFlipper/Rehabber · Columbus, OH · Member since 2013 · 1k+ posts · 655 votes
Option #2, no brainer. The key is to buy at a discount also so that the lower equity doesn't crush you if the market drops.
Originally posted by @Michael Seeker:
Originally posted by @Duncan Taylor:
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?
Fully agree on the first point (5 buildings should not be 5x the work). I put 3 times as much work in my first property as my 2nd. The time we got to our 5th, our systems took care of most of the work and we just had to initially visit and sign mortgage papers at closing (very little work). These are sub-$100k properties.
On your second point, I disagree. Unless I misread you I care deeply about negative cash flow. Personally I will never buy a property with negative cash flow regardless of any other number. You did say "for a month" and I never look at cash flow at a monthly basis (always a yearly basis) so maybe I am misunderstanding you. I almost always have negative cash flow the first month since I usually don't have a renter the first day.
- Investor · Madison, AL · Member since 2013 · 93 posts · 28 votes12y
I think you have to factor in the entire portfolio when talking about return on investment and that includes idle cash awaiting investment. Money markets are paying almost 0. Idle cash invested in properties is at least saving the cost of obtaining a loan plus the interest paid on the loan thus providing a return on idle cash. Someone that is flush with cash may want to pay cash. When the cash starts to get thin, then one can look to leverage to increase cash on cash return or total portfolio return.
- Investor · Louisville, KY · Member since 2011 · 1k+ posts · 1k+ votes12y
I agree - I was referring to another post in this thread where somebody mentioned negative cashflow in a month with vacancy (i.e. you have a mortgage payment...much less negative for that one month if you own outright).
I would never look at cashflow at the level of a single month. Month-by-month cashflow fluctuates a lot with rentals, the key is in the average you can achieve. There will always be negative months no matter what you do (new roof or new furnace for example).
Originally posted by @Michael Seeker:
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.Michael, you hit the nail on the head. This is more precisely what I was trying to get at with my original question. Sometimes the numbers are a little more skewed and you can get 10K making 25% ($2500/yr) vs 80K making 11% ($8,800/yr)
Now which would you choose?
Purely speaking the 10k is doing better for you, but the 80K will get you out of the rat race faster.
- 12yRoy N.Pro MemberRental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
It's more about the stability of the 11% (80K) versus the 10K (25%). If you could bank on 100% occupancy, then duplex would provide you better returns ... especially since you could conceivable get 6-7 more for the same cost as the 80K 6-unit.
However, one vacancy in the duplex is a 50% reduction in revenue (assumption that both units rent for the same amount) where one vacancy in the 6-unit is a 17% reduction in revenue (again, assuming all units rent for the same amount). The 6-unit offers you more revenue stability over the long haul ... slow and steady :)
This may be a little off topic but allow me to suggest a third option. A combination of both of your options.
I found a property that I purchased for $75k. The appraisal came in at $90k. I bought it using 10% down, BUT the third option is you could purchase it outright for $75k. The bank only lent me on the purchase price. However, if you bought it outright, after at least 6 months (maybe a year to be safe), you can then re-finance with the bank, then you could borrow against the appraisal value. After 1 year, my estimated value was $94k. That's a loan for $75.2k at 80%. So over the course of 6 months to a year, you've just bought a house for no money, but the downside is you have to tie all that money up for that period of time. That's called Infinite Cash on Cash Return :), after the re-finance.
Now of course, you can do the same thing by borrowing from the bank initially and re-financing after 1 year but that's 2 sets of closing costs and less cash flow during that year. So it's a multi-option 3rd option for your scenario if you will.
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes12y
Roy, slow and steady? You got that from your running partner or your wife?
Here's the important aspect guys, a 6 plex makes for better conversation than a duplex at any party or the local bar. 3x the excitement! 3x the wow factor.
My analysis is like this: If any property I can get without much money in it will pay for itself and cash flow, it's the property to have.
As to the financial side, CoC is in cash flow and part of that is the return of your capital.
If you financed 80% with a loan, the loan "owns" 80%, allocate 80% to Mr. Mortgage and see what you get above the interest he eats. Principal reduction + earnings over the interest expense. Then look at your 20%, being returned to you over the depreciation scheduled, part of that is the return of your money, the rest is the return on your money. Your CoC is better considered with the profit over the mortgaged amount + the return on your money + (1-your tax rate of the depreciation) - expenses, -tax liabilities, + the present value of any appreciation. Cash flow isn't profit nor does it increase wealth dollar for dollar. Your CoC isn't adjusted to reflect your return.
What do ya think Roy, cajol on that, LOL :)
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes12y
There is never going to be an "END ALL" answer to this question. We could go 10 more pages in discussion and new valid points might be made either way but something definitive that applies to all situations wouldn't exist.
Some will point to only wanting to be at 50% or 60% LTV. They are very conservative and views if the market drops they will still be okay. I think that was a very valid point in 2006 at the height of the market. You could also say at that time if you spotted market conditions you weren't a buyer but stacking capital for the right timing of the down cycle.
So personally I do not believe leverage hurts you if you BUY RIGHT in a recovery cycle where debt is cheap. I think those are prime indicators where leverage isn't as risky. Your cash liquidity while leveraging higher also comes into play.
Where putting all cash or most of the cash in make sense in value plays with forced appreciation where you can "recapture" the initial cash in a reasonable amount of time that meets your goals. Then you have created cash flow and have the capital back to go after more properties. Where I see people make mistakes is leveraging and overpaying for a property tog et seller finance or they do not have a level of knowledge to properly valuate whether something is a deal or not.
I run into this on apartment buildings. Some sellers the listing broker will say all cash or most down without the seller carrying a second is preferred. My response is " Sure my buyer would like a 150 basis point consideration in CAP rate to compensate for that request".
One seller recently was unrealistic and didn't want to hold a second and chose another buyer. Legal counsel couldn't come to terms for both sides and the buyer backed out. Now the listing agent wants us to come in but the seller need to 1031 by mid January which isn't going to happen on an apartment deal this size. The seller will probably pull off the market but we are on to other properties. All of these scenarios is a cat and mouse game between what a buyer wants and what the seller wants. The reality is if a buyer is required to dump all of their cash down or most of it the buyer will want an above market premium to compensate for purchasing the property.
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes12y
that wasn't much of an argument Joel ! :)
You can put my name on any title to property that I have no money in, that cash flows to me and pays for itself. That's the secret formula, don't tell anyone! :)
- Chillicothe, OH · Member since 2013 · 50 posts · 4 votes12y
Coc returns matter more as your debt/equity ratio increases, and matter less as your reserves increases.
Those are the main situations from which coc returns should be evaluated vs just return or investment. If you have minimal reserves and no equity to cover your debt, coc return is more important than roi as immediate cash flow is important in this situation. If you have 10 million in reserves and your debt is covered with sufficient equity to cover, you have plenty of flexibilty and coc returns approaches worthlessness as roi is a better investment tool.
The real question is: why would you be putting your money in a deal that was 9% yield if you invested it all upfront. 9% is terrible. The goal of investing is to make the best investment, and if that investment isn't real estate, then don't buy the real estate! The same applies with people wanting to cash flow $100 per month on a property as a goal. The return on that isn't all that great for a lot of properties. Aim a lot higher. Aim for the stars. Then if you fall a little short, your still a winner! Aim a lot higher that $100 per door if that is going to be your main strategy!
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes12y
Brian, where did you go to school?
If equity doesn't cover debt?
Are you selling something?
9% ? Not bad for the average guy, so please, school me. :)
- 12yJ. MartinPro MemberRental Property Investor · Oakland, CA · Member since 2011 · 3k+ posts · 2k+ votes
If you have more deals to do, I would use the leverage, to the extent that you are comfortable. I wrote a blog about these risks and rewards recently... Keep in mind you're also gaining leveraged exposure to price increases (and decreases) - so this greatly magnifies your returns (or your losses) when prices move.. As long as you have the CF and reserves to cover the risk, I like the leverage..
- Chillicothe, OH · Member since 2013 · 50 posts · 4 votes12y
Originally posted by @Bill Gulley:
Brian, where did you go to school?
If equity doesn't cover debt?
Are you selling something?
9% ? Not bad for the average guy, so please, school me. :)
1. Ohio Northern University. I am not a realtor. I am a pharmacist
2. Dont overleverage. If equity cant cover debt, reconsider your situation. Depends on multiple factors. Each situation is different.
3. Not selling anything
4. Investing is individual for each person. I guess return is relative. Some people would jump for joy at 10% return (?). I would say find better investments. Maybe I've just been lucky with all my investments (and Warren Buffet was even luckier!)
Ok, I want to make sure I understand what you are saying:
Coc returns matter more as your debt/equity ratio increases, and matter less as your reserves increases.
Those are the main situations from which coc returns should be evaluated vs just return or investment. If you have minimal reserves and no equity to cover your debt, coc return is more important than roi as immediate cash flow is important in this situation.
-You say Coc is more important because immediate cash flow is more important? If you CoC is high (ie-low down payment), your cash flow should be less, unless I am missing something.
If you have 10 million in reserves and your debt is covered with sufficient equity to cover, you have plenty of flexibilty and coc returns approaches worthlessness as roi is a better investment tool.
-Why would you have 10 million in reserves?
The real question is: why would you be putting your money in a deal that was 9% yield if you invested it all upfront. 9% is terrible. The goal of investing is to make the best investment, and if that investment isn't real estate, then don't buy the real estate! The same applies with people wanting to cash flow $100 per month on a property as a goal. The return on that isn't all that great for a lot of properties. Aim a lot higher. Aim for the stars. Then if you fall a little short, your still a winner! Aim a lot higher that $100 per door if that is going to be your main strategy!
-Why would you pass up good deals waiting for a great deal? How is a return of $100 CF a month not good if you put nothing down? I will take that all day long. All of these metrics have their value. As mentioned a million times previously, a lot of decisions are based on the investors goals. For me, I would much rather have a place that I placed zero money into and getting $100 a door, than one I am putting down more money to get more CF.
- Chillicothe, OH · Member since 2013 · 50 posts · 4 votes12y
Originally posted by @Pete T.:
Ok, I want to make sure I understand what you are saying:
Coc returns matter more as your debt/equity ratio increases, and matter less as your reserves increases.
Those are the main situations from which coc returns should be evaluated vs just return or investment. If you have minimal reserves and no equity to cover your debt, coc return is more important than roi as immediate cash flow is important in this situation.
-You say Coc is more important because immediate cash flow is more important? If you CoC is high (ie-low down payment), your cash flow should be less, unless I am missing something.
If you have 10 million in reserves and your debt is covered with sufficient equity to cover, you have plenty of flexibilty and coc returns approaches worthlessness as roi is a better investment tool.
-Why would you have 10 million in reserves?
The real question is: why would you be putting your money in a deal that was 9% yield if you invested it all upfront. 9% is terrible. The goal of investing is to make the best investment, and if that investment isn't real estate, then don't buy the real estate! The same applies with people wanting to cash flow $100 per month on a property as a goal. The return on that isn't all that great for a lot of properties. Aim a lot higher. Aim for the stars. Then if you fall a little short, your still a winner! Aim a lot higher that $100 per door if that is going to be your main strategy!
-Why would you pass up good deals waiting for a great deal? How is a return of $100 CF a month not good if you put nothing down? I will take that all day long. All of these metrics have their value. As mentioned a million times previously, a lot of decisions are based on the investors goals. For me, I would much rather have a place that I placed zero money into and getting $100 a door, than one I am putting down more money to get more CF.
$10 million reserves is exaggeration. You can have other assets that can be liquidated for reserves for some deals as well as equities. Obviously, $0 down on a deal cashflowing is a nobrainer; many people do that for primary residences as duplex/triplex/quad when starting. Good luck getting $0 on a significant commercial investment.
I dont know how you are thinking that im trying to say coc more important because immediate cash flow is more important? If you leverage in this example and have higher coc return and you will have lower cash flow. What im saying is if you have high debt to equity (ie significant debt), as well as having a low amount of money on hand, you are less able to take on more debt (ie the leveraged option). This is why a lot of people who leverage on SFR homes find out their bank will only leverage them 10 properties. They need different financing on the 11th property or to pay off an existing mortgage. Actually, a bank measures your debt:equity before giving you certain loans as well (as they should!).
Coc is higher when you leverage. What I'm saying is you need backup reserves (not necessarily cash) and you have to be able to cover your debt to a significant degree (depending on how much debt you have as well) with equity before taking on too much additional debt.
Hopefully I explained what I was looking to say.
This question can not be answered in a vacuum. Risk seems to be the main factor that is missed here. It is easy to say that $1500/m is better than $500/m. However I would say that Brian might have had the right intent but it came across backwards to me. If one has low reserves then reserves should be built up and any new investment has inherently higher risk because of the lowreserves position.
With 5 properties at 80% ltv you must be able to properly analyse the risk compared to 1 unencumbered property. A special assessment on one unencumbered property can be paid from excess cashflow and still be ok. If 3 of the properties have special assessments with owning 5 properties coupled with a vacancy and normal maintenance on 5 properties this would leave one in a tough spot. On its own 1 unencumbered properties is a lot more stable than 5 leveraged properties. However if one has systems in place to efficiently and cost effectively handle preventative maintenance and tenant retention as well as has an alternate revenue stream, such as employment or dividends then this can mitigate much of the risk in a leveraged path. The other variable is the interest rate environment along with lending standards. These must be weighed in to both scenarios in order to determine what would be the most prudent path forward.
I choose the leveraged path currently closer to 60% LTV primarily through forced appreciation. I purchase properties below value because of defereed maintenance and/or poor management and make the neccessary changes and capital improvements then refinance with 70% LTV loans leaving me with no money in the property but also with a healty equity position. I also have a job which allows me to put my financing on 15 year notes and makes up for slightly lower reserves. This accomplishes my goal of maintaining a strong financial base in which to grow off of. I also intend to retire from my day job within 12 years at which I will be 40 years old. I will be able to have all my current properties easily paid off by then in order to bolster my income stream and still continue to grow from a continued strong financial base.
@Brian Phillips - so you are warning against over leverage? I can understand the stance of your reply and completely agree that there is a need for reserves. I believe the discussion is what mix of leverage and reserves people utilize and that will be different for everyone.
The answer for me is dictated where I am in life. Right now, I'm starting out, and focusing on CoC. I want to maximize that in order to build a portfolio with the money I have. I want to use leverage and as little money as possible.
When I retire, I hope to have them all paid off and providing the most amount of cash flow possible. Then when I die, the free & clear properties can be passed to my heirs.
- Hanford, CA · Member since 2013 · 5k+ posts · 1k+ votes12y
We personally buy our properties through leverage. I do not feel that cheap money with in a decreased market will exist forever. Therefore we are trying to buy our 10 mortgage properties with as little down as quickly as possible. Our houses are being paid off by our tenants and my sweat equity of managing them.
We are doing the Southwest airlines model :)
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes12y
Brian, Ahhhh, your last paragraph made your point to me, it was the difficulty with prior comments I had with respect to equity. Yes, at a point the "Acid Test" applies.
Kyle, agreed and good point. Certainly different goals play on the risk willing to be accepted and how it's managed.
Before we know it, this thread will be getting into the probability distributions of a portfolio with respect to value, appreciation, debt coverage, debt retirement/maturity, gross income and interest rate risks. A bit off from a targeted cash on cash return vs. cash flow, but that's okay.
There is a tendency I've noticed by some who are aware of and using financial ratios used in corporate environments and securities that are rather useless in RE, as applicable to a small investor, let's say small under a half million gross. Small investors usually need to be more aggressive in RE. The acid test is an example, debt to assets and measuring liquidity, if you wanted a debt coverage ration of 2 to 1 most would never buy a property starting out. Analysis should be appropriate for the asset class and size.
CoC as measured on a stock portfolio that is not leveraged paints a different picture as a return than assets that are leveraged as the allocation to borrowed funds are not considered as I mentioned before. Same issues with cash flow. Use of funds will play on the opportunities you may have that implies we should consider the IRR. This is more difficult in RE as no two investments are the same risk in RE as properties are different. It certainly comes into view with large portfolios in the millions, not so much in a small holding. With securities that are graded you have risk assessed and you may have similar investments allowing you to assume a more accurate target rate in the IRR. Management is very different too, RE investors are usually more involved in RE than if the are simply calling their stock broker.
Just saying, RE is a different beast that is difficult to compare between two alternatives and especially when attempting to evaluate an opportunity in an unknown, next deal. :)
- SFR Investor · Dallas, TX · Member since 2011 · 604 posts · 243 votes12y
if you boil it all down, its the cost of money. If you can get a mortgage for the 4% mentioned (actually should be closer to 4.5% for investment deal), then what sort of return can you make in real estate.
If you can make considerable more than the 'cost of money', then go for it (keeping in mind the normal reserve requirements etc),, deals that make great sense with a 4% rate, may not make sense at all if interest rates were 7%.
One reason deals have been so good the last few years is locking in extremely low interest rates for long term. If I can get a locked in, 5% rate for 30 years,,its fairly easy to make money, and I leverage myself out,,if rates go up, I get more conservative with cash.
Obviously your situation in life and your investment objectives should always be taken into account.
andy
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