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Private Lending & Conventional Mortgage Advice

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Pinaki M.
  • Little Rock, AR
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Comparing interest rate with CAP rate

Pinaki M.
  • Little Rock, AR
Posted Mar 6 2018, 15:36

Hello, maybe someone can make this more clear for me. I used to think that as long as the interest rate of an mortgage is less than the cap rate of the investment, the investor is guaranteed to make positive cash flow every month and end up with a cash-on-cash return which is greater than the cap rate. However, working through the numbers for a few potential deals, this does not appear to be true. 

For example, I was looking at the property for which the price is $1,100,000. According to my estimates, this would result in a gross profit (cash flow before mortgage payment) of about $65,000 per year, which is just over $5,400 per month. So the cap rate is 5.9%. Now, taking a loan with 5% interest rate, 15 year amortization and 20% down, the monthly payment comes to about $6,950.

In the above example, since the cap rate is greater than the interest rate, my thinking was that I will make some positive cash flow in the end, and that the cash-on-cash (with 20% down in this case) will be higher than the cap rate (which is basically 100% down). But of course, this is not correct, as the numbers above prove.

My question is, is my understanding completely off the line, or am I missing something small? Is there any relationship between the cap rate and the interest rate at all which will quickly tell me if the investment is cash flow positive? I mean something intuitive, without having to do the whole calculation.

Thanks.

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