Cash on cash return of 4% is ok?
Member since 2019 · 37 posts · 6 votes
I'm looking at a few properties in Phoenix. Can't seem to find anything that yields greater than 4-5 percent return. Would you be ok with that return? Assume down payment is 25%-30%.
@Derrick U. I know that the reason some people aim for 12%+ CoC on deals is that they can earn 7%-8% on money in an index fund and that is alot less work than a rental property. So if you are going to be doing more work, wouldn't you want a better ROI on your money? But like Spencer said, it really matters on what your goals and criteria are.
@Derrick Umphlett keep looking for better deals. you should talk to @Scott Bower because he also has good deals!
@Derrick U. - I think it's smart to put questions like this out to the BiggerPockets community. It's a great way to get actionable feedback!
If you're looking for a quick answer, my take is: "nope" 4-5% CoC return is not attractive.
Now, that said... a "good" return to one investor is "bad" to another, it all depends on goals and investing criteria. I think it's important to take these first two steps, whenever possible, before looking at specific properties:
Good luck with the search. I live in a part of the country where CoC returns are typically even lower than 4-5% for rentals (Bay Area, CA), so I look toward markets on the other side of the country. 'Tis the burden of living in a "money" state and not a "deal" state!
I would never even consider a deal under 12% COC return. I look for 12%+ COC return for my deals, even if their hard to find.
If you can't find any leads with enough COC return for you, than you can do two things:
1) Find another neighborhood. You current location might be to inflated right now. Read "Long-Distance Real Estate Investing" by @David Greene.
2) Like @Brandon Turner always says: "Every property has a price that makes it a good deal". You can always try to make a low ball offer and see what happens.
Good luck!
@Caleb L
Thank you.
What is special about 12%? Why not 30% or 60%? My money sits in the bank getting .02%.
Where else can I invest? I'm uncomfortable investing out of state because I've never done this before.
Thanks again for taking the time to respond to my question.
@Spencer Hilligoss
Thank you.
So I guess 10%-12% return is ok?
I don't understand why however. As long as I have cash flow positive isn't that all that matters?
@Derrick U. I know that the reason some people aim for 12%+ CoC on deals is that they can earn 7%-8% on money in an index fund and that is alot less work than a rental property. So if you are going to be doing more work, wouldn't you want a better ROI on your money? But like Spencer said, it really matters on what your goals and criteria are.
think @Spencer Hilligoss hit it. You see some big players comfortable with a 4,6-8% COC vs 12-16%. Depends what type of investing you are aiming to do long term.
Also don't shy away from looking at other markets.
Also consider how long that 4% CoC return stays at 4%. If the market is experiencing 5% rent growth and the units can be fixed up as they turn and get 10% to 15% higher rents, you might see much higher CoC returns in years 2 and beyond. That's the investment thesis driving the activity in growth markets like Phoenix.
Like most things, the answer is "it depends". It is were a slam dunk, almost no risk type of situation, and I am getting that interest off of ~$10M and I just wanna be in retirement chill mode, I can do 4-5 percent and live off $400k-$500k a year. If it is a high risk, 50-50 chance I could lose my $10M, that 4-5 percent aint gonna cut it. In my personal opinion, residential rental real estate requires (threw in a tongue twister) managing a bunch of factors to go right which makes it a high risk high reward type of thing in my view.
@Derrick Umphlett I agree that it ultimately comes down to what your goals are and what returns you’re comfortable with. I’d also consider how long it’s going to take to get your down payment back with that return. If you’re starting out and putting lots of money into a deal that’s just ok, it’s going to be harder to scale unless you’ve got lots of down payments saved up or use other strategies. The great deals are out there.
@Caleb L
Thank you.
What is special about 12%? Why not 30% or 60%? My money sits in the bank getting .02%.
Where else can I invest? I'm uncomfortable investing out of state because I've never done this before.
Thanks again for taking the time to respond to my question.
Intelligent questions.
I like 12%+ for a few reasons:
1) It's easier to find in the market compared to 30%. You won't be able to get 30% or 60% COC return in the market, probably ever! 30% COC is not impossible, but very very very rare to come across.
2) 12%+ is a good return for me. I honestly try to shoot for 15%, but I'll settle for 12%. It depends on how much you want your money to grow each year, and 15% a year is suitable for me.
Try looking at surrounding cities. Ask your agent what are some of the cities people are moving to, look at neighborhoodscout.com, citydata.com, etc. You should find a pretty good city if you work hard to find it.
Hope this helps!
@Derrick Umphlett
And, I can manipulate the numbers to raise the COC. For example, with a larger down payment I could move the COC up 1-2%.
Shouldn't the net cash flow (and not the percentage) be the deciding factor?
Plus with interest being lowered and expected to go lower assets such real estate will continue to inflate. I'm guessing. Hence putting more pressure on returns until the only "deals" left are on properties in class d and c- neighborhoods. Then you have a whole host of issues.
@Caleb L
Thank you.
What is special about 12%? Why not 30% or 60%? My money sits in the bank getting .02%.
Where else can I invest? I'm uncomfortable investing out of state because I've never done this before.
Thanks again for taking the time to respond to my question.
Intelligent questions.
I like 12%+ for a few reasons:
1) It's easier to find in the market compared to 30%. You won't be able to get 30% or 60% COC return in the market, probably ever! 30% COC is not impossible, but very very very rare to come across.
2) 12%+ is a good return for me. I honestly try to shoot for 15%, but I'll settle for 12%. It depends on how much you want your money to grow each year, and 15% a year is suitable for me.
Try looking at surrounding cities. Ask your agent what are some of the cities people are moving to, look at neighborhoodscout.com, citydata.com, etc. You should find a pretty good city if you work hard to find it.
Hope this helps!
(Sorry, double posted)
@Tanner Kurilec To those here referencing an index fund investment, I would submit the argument that not all 7-8% returns are created equal. While unlikely, there is a theoretical possibility that a black swan event drives your securities investment to 0, whereas his investment is backed up by real property. Moreover, his investment can take advantage of asset depreciation, long-term capital gains taxes, and offsetting business expenses. In short, you’re going to put a much bigger chunk of your real estate 7-8% in your pocket than you are your index fund 7-8%.
As others have stated, what constitutes a “good return” can vary wildly from investor to investor for many reasons, so the decision should be made using that individual investor’s criteria and goals.
@Tanner Kurilec
Ok. Wow. I've not seen an index fund give you a 7%-8% dividend.
Do you know which index fund does that? If it's publicly traded then its subject to the wide swings in the market. Also companies can decide to cut the dividend at will. It happened to me with AGNC. That was a great REIT. I think at one point I was getting a 15% dividend but it dropped in value and so did the $/share even though the % only dropped to 12%. I sold it and did ok but it was uneasy because I felt like the value of my investment was at the mercy of the stock market and the large institutional investors involved. I didn't completely understand why and how the price moved so much week to week and month to month.
7%-8% is an awesome return!! I'll need to look up some index funds.
I like real estate because it's easier to understand. I think most adults have rented at some time or another. The stock market and bond market seem to have some hidden hand controlling it all.
Thank you for your answer. Just trying to understand this market better and you've helped me.
Short answer:
It completely depends on what you are looking for.
Long answers:
I found a property for sale which is still on the market. I have the ability to make 30% or greater cash on cash returns investing on the property. The problem is, the main employer in this small town in going out of business in 3 years. The 3 year COC may look awesome but there is more to the deal than cash on cash. That deal may or may not be better than .02% at the bank. It just depends on how you play your hand with financing, rental rates, short-term vs long-term rents, taking a cash out refi, over-leveraging, under-leveraging, etc. The ability to be in control and have a dynamic operation with real estate is why I would say "depends". With commercial paper, annuities, bonds, certificates of deposit, etc., its easier to take a CoC return approach.
I would also recommend analyzing your properties through the lens of IRR. This accounts for the time value of money, the cash flow, and any exit/refinance if applicable. If you are ever going to sell or refinance, don't forget to factor that in.
You asked Spencer "As long as I have cash flow positive isn't that all that matters?". If I understand the question correctly, you asking that as long as you cover expenses, debt service, and a little extra, then aren't you good on your investment? Sure, I guess the answer could be yes if all you wanted was paying down the mortgage over 10 or 25 years and then having cash flow to retire on. Putting 25% down in a presumably stable market and paying down the mortgage is a clean, simple way to invest, but you aren't going to get as high of returns as you could. I only look for very high percent ROI deals but I utilize seller financing, creative leverage, refinancing, investors, etc. It is less simple than the conventional strategy, but you can get 10x the return you would have otherwise gotten.
@Caleb L.
Thank you for taking the time to respond.
@Bryan S.
Thanks Bryan
I looked up all the funds and etfs offered at vanguard and the only two that are above 4% (barely above) are vembx and vgavx. The ytd's are much higher but that's just price appreciation which goes up and down. It could drop lower by the end of the year or the end of ten years. It's hard to say. And those are bond funds so with interest rates around the world at all time lows the next direction for bonds in the long run is down as interest rates rise. I don't see that happening in the short term.
If you know of any index funds that are low to moderate risk, reputable and with a 7%-8% dividend let me know. I can't find any.
I guess I'm willing to accept a lower return because
1. I know the area
2. It's better than parking my money in the bank
3. I understand this investment the best (people give me money and I provide a place to live)
4. Eventually I will own the property free and clear with only the noi (which is my financially free vehicle).
@Daren H.
Thanks Daren
I wouldn't mind living off of just $100k per year.
@Derrick U. 4-5% sounds really crappy but you should never use any one measure in isolation to evaluate the return on your investment. Be it caprate, CoC or even CF each can be skewed to give you a completely misleading result. Look at the whole investment and see how it ranks with your objectives and criteria.
@Derrick Umphlett many people use 12% because that’s what Brandon Turner uses on the podcasts (I’m guilty of it as a reference as well). He admittedly settled on 12% because the average stock market return is 6%, and he wanted to double it.
While i follow it I certainly don’t believe it to be gospel, but I also would be wary of 4-5%. The primary reason is unforeseen circumstances. Even with reserves accounted for before cash flow, a major capital expenditure (especially early on) will not just wipe out your reserves but also could easily wipe out years of cash flow at a thin margin.
It all just depends what you’re comfortable with. At the end of the day, nobody is going to give you a “right” answer on this. But they can all provide the rationale behind their decision, which can help you weigh the pros and cons for yourself
@Derrick Umphlett
We keep hearing 12% COC is the benchmark on here because that is compared to the stock market and "If you can't beat index funds why put in the extra work".
Well that argument is missing a large part of the picture. Yes, 12% COC is good and all but only looking at COC and comparing it to other investment vehicles is primitive at best. Several things worth pointing out, your down payment doesn't lose its value when it is put into a property, rather it is converted into equity. Further, as you make mortgage payments (or ideally your tenants make your payments for you) a portion of every payment builds further equity. If you look at the amortization schedule, it is common that the equity build contributes a larger portion of the total return than the COC. Then of course there is the potential for appreciation that is on top of the amortization and COC.
One way to look at it would be if you take an example. Let's say you purchase a property for $100,000 with $25,000 down. It rents for $1,000 per month (meets the 1% rule). Expenses are $500 (following the 50% rule). And you have a 30 year mortgage at 4% putting your monthly payment at $358.06. Cash flow is $141.94 per month or $1703.28 per year. COC return is 6.8%. However, at the end of one year, your loan balance is $73,679. In other words, you have added $1,321 in equity in the first year, which comes to an additional 5.3% return. Now we are above 12% total return before taking any potential appreciation into account. Each year, more is applied to the loan balance as the interest decreased and this equity build rate increases.
I hope this makes sense. Let me know if you want to chat more about it.
@Brian Burke
Until all these class A rentals come online and put downward pressure on class b and c rentals.
Also the jobs may disappear. Are these solid AAA bonded companies coming to Phoenix? I'm sure some are or maybe most but I'm also sure that some aren't. For example, Zenefits went under. Anyway, I see your point. I appreciate your perspective. I didn't think of it that way.
My goal is financial freedom. I work everyday but I'm at the mercy of others with more money than me and until I can say "bye bye" to my job I have to walk around with my tail between my legs until I'm free. That freedom is just several thousand a month. I hot that and I'm good. I would love to be where Grant Cardone is or some of you guys on here are but that's not my goal. Just financial freedom with a middle class income. Certainly I'll go higher if I'm energetic enough but I feel Father Time breathing on my neck every now and then and I'm a little tired of waking up to an alarm and dancing to the beat of another drum.
Just venting. Thanks again.
@Patrick Menefee
Ok. That was awesome. Thank you.