In addition to benefits like principal paydown or asset appreciation, cash on cash returns that should be enjoyed every month, is yet another great aspect of investing in real estate and realistically all that will matter at some point in your life if you wish to create enough income to either supplement or replace an income. Yes, people can trash your property, hurricanes can come, meteors can fall from the sky, toilets can get clogged up, water heaters wear out, batteries die in smoke detectors (always about 2-3 am in my house), and a host of other worrisome frets that can mainly be avoided or dealt with and managed with a long-term perspective in mind.
Now let me stop right here! Unless it is your strategy to purchase severely distressed properties and rehab, rebuild or replace then do not buy a rental property that does not have cash flow. Banking solely on appreciation and no cash flow is how millions go broke and file bankruptcy. You probably have enough expenses, don’t buy another one because you mistakenly thought you were building wealth. If something is taking money out of your pocket every month, then it is a liability and a path to financial destruction. I have seen people create for themselves heavy financial burdens by making horrible investment acquisitions after creating some fabricated tax scheme and grandeur of appreciation off in la la land in their mind. The point of this is to understand the long-term benefits of creating wealth over time through the vehicle of real estate through cash-on-cash, loan principle paydown, and asset appreciation.
Cash-on-cash (CoC) is a way to measure the cash flow percentage derived from an investment that you made. Generally, cash flow investors will look at cash on cash returns, as a starting point when considering an investment or comparing multiple investments. Cap rates, Internal rate of return (IRR), and return on investment (ROI) do not always rule the day, they are just more metrics to be discussed at another time. You cannot go broke if every deal you make has positive cash flow from day one.
Let me help you remember how to calculate cash on cash. Think… How much Cash will you put IN your pocket every year? After all, this is the end goal. Divided by how much cash you pulled OUT of your wallet one time? You could remember it: divide Money In by Money Out. That is money IN your pocket/money paid OUT to get it.
Let’s take a look at a simple spreadsheet that I created and started using back in 1999, initially just to calculate cash-on-cash returns quickly, but ultimately led me to become a millionaire from all of the other benefits that we have outlined in this book. The idea was to quickly analyze deals with some very basic research and inputs.
For example, this was a single-family property that we acquired in 2016 for $224K with 25% down (so we would get a break on the interest rate vs. 20% down). That was $56,000 out of pocket. But wait, there’s more. We had closing costs +/- 2% and some light improvements to the property totaling about 4% of the purchase price combined or $8,960 total… that’s OUT of my wallet $64,960 (see my deal analyzer below or go to my website and download for yourself).
Now, start adding up all your expenses (and I include everything) … Mortgage payment (principal and interest), insurance, taxes, utilities for cleaning and showing, property management, termite/pest contracts, POA dues if any, vacancy factor for the area, etc. Cost of ownership = $1,317/month. I did my homework by looking up rents in the area and knew rental rates for this area at that time was about $0.70 to .75/sq. ft. We rented this property for $1,950/month. To find the cash-on-cash return, take $1,950 rent and subtract all the expenses of $1,317 = $633/month or $7,590/year. Now you know how much money will be IN your pocket if your projections go as planned over a year.
Thus, the basic math is $7,590 (IN) your pocket / $64,950 (OUT) of your wallet = .1168 or 11.68% Cash-on-Cash return.
How is this helpful? Well, let’s say you found another property (DEAL 2) for $225K and it didn’t need as much work, so less money out of pocket. Great, right? You build a spreadsheet in Excel like I did after the first go around and now you punch in the numbers on this one. This one will put $5,345 (IN) in your pocket and it will require $67,500 (OUT) of your wallet. What will be your cash-on-cash return? Divide $ IN by $ OUT to get your first-year cash-on-cash return. Which purchase is better from a cash-on-cash perspective?
Here is another example of a property that I purchased in my local market in 2021. We acquired it for $385,000, got into rehab, and blew out a budget as we found unforeseen issues, putting around 24% of the purchase price into closing and rehab or approximately $92,400 into the property. After researching the market rents and calculating an anticipated rental rate, taxes, vacancy, and all other related expenses, you can see in the illustration that our investment of $188,650 would have resulted in an estimated annual cash-on-cash return of $13,729 or 7.28%. Even with the unexpected additional capital expenditures, the property would have been in a decent cash-on-cash position with a nice equity position because we strive to run our numbers and buy right. Remember, you make your money on the purchase, not on the sale. The after-repair-value (ARV) was in the $180 sq. ft. range in this neighborhood or approximately $625,000.
It is difficult to go broke when buying for positive cash-on-cash positions, in the event of an economic shift or other unforeseen circumstances, having positive cash flow will allow you to weather most storms. Thus, stress testing or writing in worst-case scenarios when considering a purchase will aid in keeping you out of trouble. In this particular case, we ended up selling this asset after the renovation rather than executing a tax-free, cash-out-refi because rates had begun to move up during the rehab and we were beginning to lean more into syndicated offerings. The home sold for $621,000 and we recaptured our initial down payment and capital improvement investment, plus minimal profits, and entered a syndicated opportunity with our capital in a better cash-on-cash position which required less time, energy, and effort on my part.
A word of caution to her about just jumping into real estate. Just recently, I ran into a chap who had just moved to the area and he was expressing how he wanted to desperately get into the real estate game. His desire was so bad, that he had a HELOC (home equity line of credit) on his primary residence at 8% and was ready to put that $125,000 of dead equity to work. He told me how one of his neighbors was going to sell and he could get a “good deal.” I believe it was providential that I met him that evening and we discussed his situation before he bankrupted his family.
He lives in a nice neighborhood, our area is growing by all measures (wages, jobs, population), single-family homes will seemingly continue to do well, and he was raring to go. The deal basics were a purchase price of $500,000 for about a 2,700 sq ft home in a nice neighborhood (his neighborhood), the bank was offering about 7% on a 30-year fixed loan and his HELOC was about 8%. This was in the 4th quarter of 2023. I am in the market here. I know my numbers. I have a spreadsheet. I can calculate cash on cash. I know what rental rates per sq. ft. are and what a property sells for on average per sq. ft. as well as my cost to build ground up. It’s the difference between research and experience versus “I feel an uncalculated whimsy coming on.” He was headed for the top of the ski hill with no experience, instructor, or basic knowledge needed to navigate what he was about to do.
I took what he was telling me, opened my Excel sheet on my phone, and began to share it with him. I will “share my screen” here for illustration and make the point on how to go broke thinking you are a real estate investor or wanting desperately to get in the game of building real wealth. You can readily see that financing 100% of this deal would have added $14,295 in expenses to his family’s budget. Even removing the HELOC funding of $8,805 a year would not make this a cash-flow-positive deal! This man would have committed a grave error and purchased a huge liability for his family. People like this try investing and then tell others years later of how horrible investing in real estate is. Really?!?!
