Better Understanding COCR and ROE

[Brian Quist]

Hello All,

I'm an owner of a few different rental properties. 2 multifamily and 1 single family. Seattle/Los Angeles.
Feeling confused on how to accurately calculate Cash on Cash Return and Return on Equity rates

Question is, should I combine annual cash flow as well as annual mortgage loan pay down as these 

For example:

single family house. total cash invested $106k. Annual cash flow after all expenses is $10,000 (not great).
So my COC should be 1.6%.
But if you factor in the loan pay down the annual cash flow increases to 17,688.
which would make the COC 3%. (still not great).

which is it?
thx

[Jim K.]

Quote from @Brian Quist:

Thank you so much for the reply Adam. The differentiation between COC and ROI is helpful. My initial question was mostly just to help me better understand how to properly evaluate my properties so that I can decide what to do next - based on what I'm seeing elsewhere in the market.

Question: How and where would you factor in the appreciation of the property?  For example if my equity in the property increased by 50K the last year would you add that to your ROI?

My COC and ROI aren't terrible on this property we're using as a reference.  However, my return on equity isn't as strong. As you mentioned coastal appreciation has put my equity at $570k.  When you run that against the total income of $17,688 you get 3.1%.

Which does lead to your ultimate question of what to do with this info.  I'm leaning towards selling this house soon and moving that equity into a variety of stronger real estate investments: syndication, or possibly building on one of my other properties where I can realize better returns.  Sounds like you have clear goals based on your region and niche.

I appreciate the reply and dialogue. 

You bring up a great point that a lot of investors miss because they focus strictly on cash on cash returns. 

I'd recommend calculating an annual, net return. You can use that to calculate your ROE.

Net Return Components:
Net Cash Flow (after expenses, reserves, and debt)
Appreciation - 2-4%/year
Principal Pay down - use PPMT formula in Excel
Depreciation/Tax Deferred savings - Use your tax bracket to calculate your savings/deferral.

Once you have your annual Net Return, you can calculate your Return on Equity by taking the properties equity (current value - 6-8% selling costs - debt) divided by your Net Return. 

I prefer to be more exact and account for selling costs to accurately reflect the attainable equity, but others may skip including realtor/closing costs.

In general, if I'm getting an 8% cash on cash return, my ROE is likely around 12-16% year 1.