cash on cash return (Should I cash out with a mortgage?)

Real Estate Deal Analysis & Advice
13yFollow

cash on cash return (Should I cash out with a mortgage?)

Will Murphey
Residential Real Estate Agent · Phoenix, AZ · Member since 2011 · 23 posts · 6 votes

Hi all.
Please review my analysis of increasing my return on my ‘paid off’ rental property.

Today I read a book that described cash on cash return vs ROI. and I'm thinking about obtaining a mortgage to get a better return and using the cashed out proceeds to look for another deal.

Details:

Purchased price 15 months ago with updates (new roof/paint job) was $22,400 (purchased with cash)
Cheapest 2 bed/1 bath today is $39,900 in my town on MLS.

Rental income last year: $600 per month on HUD
Property manager last year: 8% monthly
Last year expenses: $120 (wife and I replaced the tub handles/hardware) I will forecast $500 for the upcoming year.

Taxes paid last year: $383
Insurance paid last year: $480
Vacancy last year: None (Although I'll forecast 2 months vacancy for the NOI calculation below (2 months vacancy hopefully is the worst case scenario)

HOA: None

If my numbers are right my NOI in 2013 might be: $4147

Income: $600 rent* 10 months = $6000 annual rent
Property mgt: $6000 *.92% property mgt (8%) = $5520
Taxes: $5520 - $383 = $5137
Insurance: $5137 - $480 = $4657
Projected expenses: $4657 -$500 = $4147

If my calculations are right, my ROI this next year might be 18.51% if nothing changes.

Please review my thought process below regarding obtaining a mortgage. (Thanks in advance!!)

Obtain a loan from the bank at 4% interest rate for 30 years, put 20% down of $22,400 (my purchase price) Although maybe the bank will give me a loan for more, not sure how this works or how it would affect my cash on cash return.

After running a few mortgage calculators, my debt service on the assumptions above will be $107 monthly.

So my cash on cash return for 2013 might be: 63.9%

$4480 (20% cash outlay) / $2863 ($4147 NOI – Annual debt service $1284 (12 months * $107)) = 63.9%

I few things I don’t understand or where they fit into the calculation are:
If the bank/appraiser says the house is worth what I paid for it $22,400, do they simply cut me a check for $17,920 ($22,400 house value – my 20% down payment)?
Closing costs— Can this be financed in? If so, how does it affect my cash on cash return?
If the house is worth $35,000 by appraisal, can I / should I get a loan for that amount? How would that affect my cash on cash return.

Thanks for looking at this!!!!
Will

0Reply
38 views

Most Popular Reply

Sebastien B.
Contractor · New York, NY · Member since 2012 · 30 posts · 12 votes
13y

I'm a proponent of having as little equity in my investments as possible. The only time I see a need to have more equity in an investment is when its the only way to increase cashflows.

I.E if cap rates are 10% and interest rates are 11%, I make 1% more for decreasing debt instead of decreasing equity.

Right now, for every dollar you take out of equity and use for another levered investment, the better off you are.

1Reply
See this reply in the discussion

10 Replies

Jump to latestLatest
  • Sebastien B.
    Contractor · New York, NY · Member since 2012 · 30 posts · 12 votes
    13y

    I'm a proponent of having as little equity in my investments as possible. The only time I see a need to have more equity in an investment is when its the only way to increase cashflows.

    I.E if cap rates are 10% and interest rates are 11%, I make 1% more for decreasing debt instead of decreasing equity.

    Right now, for every dollar you take out of equity and use for another levered investment, the better off you are.

    1Reply
  • Sandy Blanton
    Residential Real Estate Broker · Pensacola, FL · Member since 2012 · 221 posts · 49 votes
    13y

    The lenders will lend up to 80% of appraisal minus closing costs. In a refinance, the amount you have invested doesn't matter, only what it appraises for at the time of loan. The more equity you have in your portfolio, the stronger you'll be financially. I owned 100 units at the peak of the market and had a "I don't want equity" mindset as so many of us did. Then the crash happened and I went flat broke.

    On the other hand, rates are incredibly low. If you can refinance and find other investments that return double-digit returns (cash on cash), then by all means move forward.

    0Reply
  • Michael Lauther
    Investor · Hampton Bays, NY · Member since 2009 · 907 posts · 258 votes
    13y

    Will your numbers are great the challenge will be to find a lender that will underwrite a small loan. Let us know If you find one.

    1Reply
  • Will Murphey
    OP
    Residential Real Estate Agent · Phoenix, AZ · Member since 2011 · 23 posts · 6 votes
    13y

    Thanks for the feedback so far!

    Can anyone help/check my figures on my cash on cash return based on the assumptions below? Thanks!!!

    Say the appraisal comes back for $25,000

    Would my Cash on Cash return be: 66.5% ??????

    Loan amount = $20,000 (80% of $25,000 appraised value)
    Cash back in my pocket = $18,000 ($20,000 loan amount - $2000 closing costs)
    Annual Debt service = $1152 [$96 * 12 months] ($20,000 loan at 4% for 30 years)

    My purchase price $22,500 -18,000 cash from bank = $4500 skin in the game

    cash on cash return calculation:

    $4500 (skin in the game) / $2995 ($4147 NOI - Annual debt service $1152 (12 months * $96)) = 66.5%

    0Reply
  • Sandy Blanton
    Residential Real Estate Broker · Pensacola, FL · Member since 2012 · 221 posts · 49 votes
    13y

    Looks right to me.

    0Reply
  • James H.
    Investor · Fort Worth, TX · Member since 2011 · 1k+ posts · 450 votes
    13y

    My opinion is that your margin will be to thin even if the COC calculation is great.

    I have an almost identical scenario with my rental. You will eventually have to make a capital improvement (roof, sewer line, etc). Right now, using your projected expenses makes it seam like it would be fine to add debt service to the property. But once that cashed out refi money is gone and you have a big repair to perform on the property, suddenly what is left over after the mortgage payment is made is not very exciting.

    0Reply
  • Tim Delp
    Real Estate Investor · Jacksonville, FL · Member since 2012 · 109 posts · 22 votes
    13y

    Your roi will increase based upon your cash you have in the property but your risk will increase. Only you can answer that question as to what is best for you.

    Generally banks will consider doing a cash out refinance after 12 months of ownership based upon the current appraised value. A cash out refinance on an investment property will typically be capped at 75% LTV.

    If you are wanting to acquire more rentals and feel that you can acquire more similar to this than adding leverage sounds like it might work for you. As far as how much cash should you take out, I would suggest you take as much as possible when you do the refinance as you will pay closing costs and would want to take advantage of financing as much as possible on 1 property that you can.

    As someone mentioned one issue is many lenders don't like to do these small loan amounts and then you have consider the closing costs will most likely be several thousand dollars to borrow the money. If closing costs are $2,500 and you borrow $25,000, it is costing you 10% upfront to borrow the money. Probably still worth doing if you want to and are able to continue buying more properties just like this one.

    I will be looking at similar situation for a property I paid $35,000 cash for at the end of June 2012, hoping to do cash out to take all of my money back out of the property in July of this year.

    0Reply
  • Will Murphey
    OP
    Residential Real Estate Agent · Phoenix, AZ · Member since 2011 · 23 posts · 6 votes
    13y

    Thanks for all the input thus far!

    0Reply
  • Derek J.
    Investor · LOS ANGELES, California (CA) · Member since 2010 · 27 posts · 4 votes
    13y

    Will Murphey: have you found a lender that will do this loan?

    0Reply
  • Will Murphey
    OP
    Residential Real Estate Agent · Phoenix, AZ · Member since 2011 · 23 posts · 6 votes
    13y

    Not yet Derek, I just posted this thread yesterday. I’m still gathering feedback from the biggerpockets community.

    Thanks, Will

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free