I'm a first time RE investor running some numbers on rental properties available in my area (Connecticut) specifically on single families and duplexes. I understand the difference between Cap Rates and Cash on Cash Return rates. But having trouble grasping what is more important when my goal is to generate passive income. For example I'm looking at one property with a 1.9% cap rate, but 8.1% CoC.
Plymouth, MI 路 Member since 2013 路 13k+ posts 路 19k+ votes
5y
CoCR because CAP rate is a commercial analysis tool...not a residential one. There is no debt service in the calculations. It was designed to be able to compare different types of commercial RE with eachother.
Real Estate Agent 路 Portland, OR 路 Member since 2016 路 1k+ posts 路 605 votes
5y
Hey @Krystian Kucharzyk, I bet you will get both answers and lots of reasons why. I prefer to look at cap rate instead of COC or ROI. The reason is that the cap rate gives you a current indicator where cash on cash will change each year. I live in an appreciating market so I expect rents to go up quite a bit every year. Honestly, if I were you I would analyze for both and see if you can find a coralation.
Plymouth, MI 路 Member since 2013 路 13k+ posts 路 19k+ votes
5y
CoCR because CAP rate is a commercial analysis tool...not a residential one. There is no debt service in the calculations. It was designed to be able to compare different types of commercial RE with eachother.
Hey @Krystian Kucharzyk, I bet you will get both answers and lots of reasons why. I prefer to look at cap rate instead of COC or ROI. The reason is that the cap rate gives you a current indicator where cash on cash will change each year. I live in an appreciating market so I expect rents to go up quite a bit every year. Honestly, if I were you I would analyze for both and see if you can find a coralation.
CoCR is only applied to the first year of an investment. There is no "year after year" involved.
CAP rate is a commercial tool...not residential. This specific question is for SFH and duplex, so the correct answer would be CoCR.
Real Estate Agent 路 Ridgefield, CT 路 Member since 2016 路 72 posts 路 37 votes
5y
Hi @Krystian Kucharzyk, since your goal is passive income, I would focus on the CoC for each property. Leave Cap rate to the commercial world and for when your investing goals change. Best wishes in your search!
CoCR because CAP rate is a commercial analysis tool...not a residential one. There is no debt service in the calculations. It was designed to be able to compare different types of commercial RE with eachother.
Exactly. Cap rate does not apply, and is not a return metric anyway, even for commercial.
Rental Property Investor 路 Sioux Falls, SD 路 Member since 2015 路 9k+ posts 路 18k+ votes
5y
These numbers don't makes sense. Can you share all the numbers with us, because I suspect you made some computational errors.
With a 1.9% CAP rate, assuming a 30 year loan at 3%, you would need to make a 74% down payment to cover your loan and get a CoC of around 8.1%. In this example to even cover the loan P&I payment, you would need to put down 62.5%. If you adjust that interest rate higher, your cash out of pocket just gets larger.
Did you accidentally reverse your down payment and loan amount when you ran the numbers? Investment loans normally require 20-25%. The less money you put into the deal, the higher your leverage.
Although I agree with others that CAP rate is not the best measure in a duplex or single family, it is still is an indicator of NOI (net operating income). Some level of net operating income is needed to cover your loan payment.
5% Closing Costs: 11750 (5% x 235k) Est repairs: 1k Up front costs: 59,750 (47k+11750+1)
CCR: 3.71% (2,214/59,750)
You are including your principal and interest in your NOI, which you are using to calculate CAP rate. CAP rate assumes cash purchase, so you just include taxes and insurance (no principal and interest). That increases NOI by about $897 per month ($10,764 per year) and your CAP would be around 5.5%. CAP rate is really just confusing things for you, so just stop using it.
Just FYI, if you have PRO membership on BP, there are deal calculators that will do all the math for you and prompt you to fill in expenses you may have forgotten.
Rental Property Investor 路 Cranbury, NJ 路 Member since 2021 路 13 posts 路 8 votes
5y
@Joe Villeneuve - all my residential condos have commercial mortgage. We have to look for both CoCR and Cap rate also to see if we are making some money. 馃榾
@Joe Splitrock ahhh thanks for this! Ya I know PRO has a calculator, which I may use in the future, but I like doing the calcs on my own since I'm just staring out and want to understand the calculations and implications first :)
Investor 路 Marin County California 路 Member since 2018 路 1k+ posts 路 2k+ votes
5y
The best you can realistically do on a rental is to calculate a maximum or a minimum Cash on Cash return. Due to the vagaries of rental house investing, you will seldom see the exact same revenue in two consecutive years and, in fact, may experience wide variations as capital expenditures come into play. A property that has a superior seeming cash on cash return may in fact perform more poorly - due to capital expenditures, vacancies, vicious tenants, etc - than a property that on paper looks weaker.
Investor 路 Singapore 路 Member since 2013 路 1k+ posts 路 3k+ votes
5y
Metrics are just tools. Just like anything else, the tool you choose depends on what you want to achieve. If you want to compare across investment types use IRR or ROI (a simplified IRR that ignores time value of money). That will take into account mortgage pay down and appreciation.If you need to live off the income, calculate total cash flow. That will ignore mortgage pay down and appreciation.
As @Joe Villeneuve mentioned....cap rate is used when comparing commercial properties. Even though Duplex is said to be a multi-family investment it is bought using a residential loan. One to four units are residential thus they are valuated by local comps, not cash flow. If you are looking at 5 units or more then you can throw out CAP Rates and NOI.
Let's keep it simple. What is your rent minus expenses (taxes, Insurance, Mortgage, CapX, Vacancy, etc) and that leads you to your cash flow. Cash on Cash is a good way to see how much you are making on your money. As a new investor, all you are worried about is how much money will you make a year buying a house/duplex. And if you like the amount then move forward and buy but everyone has their own preference on the amount so find yours.
Any time I hear an Agent list Cap Rate on a single-family home I know they don't know what they are doing.
Some would argue a Cap Rate is not a good measurement to use in Multi-Family, unlike true commercial-like Triple Net properties. But won't overcomplicate things.
Great to see you are looking at properties so best of luck
You might have a commercial mortgage if you packaged the condos together especially if you got a loan from a local community bank. However, I am sure you can sell off one at a time to someone who wants to buy to live in. So Cap Rate really doesn't apply in your case if it's a portfolio loan. I am just assuming based on the small amount of info you had on your response. If I am wrong I apologize in advance.
CoCR because CAP rate is a commercial analysis tool...not a residential one. There is no debt service in the calculations. It was designed to be able to compare different types of commercial RE with eachother.
Exactly. Cap rate does not apply, and is not a return metric anyway, even for commercial.
CAP Rate doesn't tell you anything of value since the number doesn't include the loan payments.
CoCR only tells you how much of the cash you spent in your first year, you get back in that same first year. What about after that?
The numbers you should be looking at are Cash Flow...and using that same CF number, how long will it take to recover all of your cash?
@Joe Villeneuve - all my residential condos have commercial mortgage. We have to look for both CoCR and Cap rate also to see if we are making some money. 馃榾
What does having a commercial mortgage on have to do with anything? That doesn't make it a commercial property. That just means you financed it using different terms.
@Joe Villeneuve - all my residential condos have commercial mortgage. We have to look for both CoCR and Cap rate also to see if we are making some money. 馃榾
What does having a commercial mortgage on have to do with anything? That doesn't make it a commercial property. That just means you financed it using different terms.
I also have to ask, how does CAP rate tell you that you are making money when you finance a property? Any property that is an all cash purchase will produce income. If a property doesn't produce income when you pay all cash, using financing will just make it worse. Ultimately CoC and CAP rate both use net operating income, but CoC is return with the loan included. As Joe said, the commercial loan is of no relevance in this situation.
Rental Property Investor 路 Clarkston, GA 路 Member since 2012 路 2k+ posts 路 1k+ votes
5y
@Krystian Kucharzyk I use neither as my buying criteria. Please read the file I have linked off my bp profile, bullet proof portfolio.
I use the cash flow per door of rent minus piti must be >$300. This is the gauge of passive income.
Others will say this doesn't cover expenses or manage. I self manage, rehab well post purchase so my expenses are near zero as are my turn over expenses. Ie read bullet proof! Rent goes up every year, so my net goes up too.
Yes have reserves to fix or replace the ac and roof, but passive income starts with rent minus the mortgage...