Cash on Cash, IRR and the BP Calculators

10 Replies

Brandon Turner at BP mentions all the time that his metric for analyzing a property is that he wants 12% Cash on Cash and $100/unit cash flow....

In trying the exercise of applying Brandon's requirements using the BP calculators to some potential deals, the Cash on Cash (CoC) return is typically coming in really low and I am assuming the CoC value that is returned in the report is for year 1 only....is that correct?

If that is the case, does anyone know if Brandon looks for a CoC of 12% for year 1 only, or as an average CoC over the period the investment is held? While the CoC may be low in year 1, it does go up quite a bit after year 10. This distinction makes a huge difference in how an investment may be interpreted.

Secondly, why is IRR not included in the BP Calculators or is it and I am somehow missing it?

Thanks,

Jordan

@Jordan S. The COC is only for one year. How much cash are you putting down on your deals? More than 20% invested? That would cause your cash position to be relatively high and return a lower amount.

I personally don't use IRR in my calculations.

I look for 10% COC and no less than $150/unit when analyzing buy and hold strategies. They aren't abundant in over priced areas but you can still find that in just about every market, they just may not be on the MLS.

@Jordan S. From my understanding, Year 1 CoC is 12% but maybe @Brandon Turner should chime in. 

For residential properties, more complex metric like IRR serve little or no purpose. They also make the calculations unnecessarily complex.

You are good with the basic investment metrics for residential properties.

@Omar Khan  Can you define "Residential" in the context you use?  Do you mean 1-4 units, or anything where people live even though the lending world calls anything over 4 units "Commercial"?

In speaking with a very knowledgable & seasoned "commercial" lender specializing in 1-10 Million dollar loans for multi-unit residential investment properties, he uses IRR as his main metric.

The reason for the question is that I want to use the BP calculators to analyze the deals accurately while also using the lender's spreadsheet to double check the calculations but with different metrics the comparisons are tricky.  The lender's system also uses an average cash on cash return metric where as the BP metric sounds like its just year 1.  

@Ryan Blake - good point about the money down...I'm using 25% as that is what seems to be required for conventional and commercial loans under 1 million. Most of the properties I'm looking at are $250-500k and its been a trick finding anything where the COC in year 1 is even double digits, let alone 12%. I think some of these investments make sense for other reasons but I'm just trying to run through the exercise of comparing deals to what folks like @Brandon Turner are doing.

@Jordan S. 1-4 units or even smaller properties below 20-30 units. 

I wouldn't recommend using BP calculators if you're buying properties in the millions. There are a lot of moving pieces and you will be in for a rude shock if you use the BP calculators (not designed for $1-10M MF properties).

IRR is a good metric but you need to have a solid grasp of the assumptions before you should use it. If you have it, go for it.

Cash on Cash return is really only useful for when you are analysing a potential deal. Once you purchase the asset, any non-equity expenses (appraisal, loan fees, transfer tax, etc) which ARE part of your initial cash outlay (& effect your CCR), are unrecoverable sunk costs.
Beyond this, the relevant cash flow metric is your Cash on Equity return - this is the amount of net cash flow the asset generates as a function of the amount of equity you have in the property, and will (generally) decrease each year as you equity increase will outpace your rent increases.

Once your cash-on-equity decreases to below your personal threshold for investment returns, it’s time to consider moving the equity to a different asset in which it can give a better return.

@Omar Khan  Gotcha.  Didn't know that was a limitation of the BP Calculators....good to know.  What amount or size investment are the calculators good through?  Is this specified anywhere?

I'm not actively looking for a million dollar property but an off-market property presented itself and it seems to work at some level so I was digging a little deeper on it.  The BP Calculators were suggesting the deal was mediocre, while the commercial lender thought it was a pretty good deal.  Maybe I'm overanalyzing this one but the learning curve seems to be steep on the higher dollar properties.

@Jordan S. The BP calculators are designed for single-family homes and small MF (1-4 units) which basically act as single-family homes. They should serve the purpose if that's what you are looking at. 

The lender/broker/agent are incentivized to sell you the house. They will hardly tell you anything is bad! You must do you own research. Don't be in a hurry and just understand the moving parts. 

You're set once you get that!

@Ryan D.  Good points and interesting metric I haven't heard much about.  I don't see Cash on Equity Return on the BP Calculators either.  What is the COE you shoot for on initial purchase and when do you refi to reallocate the money elsewhere?  I know this will vary from one person to the next but curious since you use this metric what your numbers are... thanks

@Omar Khan  LOL - that is exactly what happened when I initially spoke with this commercial lender (he thought it was a good investment and I thought it was so-so).  But I drilled him and he said he'd have to re-run his numbers.  He still came back saying it was a good investment but with far better reasoning on his end.  I then asked him to run a property I knew wouldn't work and asked him the same question.  He had actually already ran that one for another investor and was familiar with it and said he could get it to work at 75% of the asking price, but at the asking price there was no way, so I am starting to trust his approach.  

It would be very cool to see additional metrics in the BP calculators to make them applicable for >1-4 unit investments, or perhaps even additional calculators.  I'm good with Excel but the speed of the calculators and fast reports are a nice feature.

Originally posted by @Jordan S. :

@Omar Khan  LOL - that is exactly what happened when I initially spoke with this commercial lender (he thought it was a good investment and I thought it was so-so).  But I drilled him and he said he'd have to re-run his numbers.  He still came back saying it was a good investment but with far better reasoning on his end.  I then asked him to run a property I knew wouldn't work and asked him the same question.  He had actually already ran that one for another investor and was familiar with it and said he could get it to work at 75% of the asking price, but at the asking price there was no way, so I am starting to trust his approach.  

It would be very cool to see additional metrics in the BP calculators to make them applicable for >1-4 unit investments, or perhaps even additional calculators.  I'm good with Excel but the speed of the calculators and fast reports are a nice feature.

I like the calculators as much as the next guy, but if you are investing in anything besides residential Real Estate, you probably aren't using the BP calculators. If you are, you should probably take a hard look at your investing process and decision making paradigm. 

Sure it would be cool, but they would go unused since they wouldn't have a high degree of functionality and would have a "black box syndrome" that hides implicit and systemic assumptions that may not hold true in every case.