cash on cash rate - what should it be

[DollahBillYall]

This question is for real estate experienced folks. I am fiddling around with the cash on cash formula for rental properties and I am in need of determining just what the cash on cash rate "should" be. If I want to work the equations backwards (using the COC x downpayment) to determine net annual income, what COC should I use? I've seen people pick it out the air (6.8% sounds good to me) or justify it somehow.

For those of you who have no confidence in the formula please skip replying.

Thanks

O0
DBY

 

[Sam]

For those of you who have no confidence in the formula please skip replying.

Geez, there goes my chance!

 

[OAG]

Cash-on-Cash Return

 

[Nords]

If I want to work the equations backwards (using the COC x downpayment) to determine net annual income, what COC should I use? I've seen people pick it out the air (6.8% sounds good to me) or justify it somehow.

This reminds me of the perpetual SWR debate-- the answer is 4.28579%. Or maybe it's 42.

A better answer is "it depends". 6.8% beats today's long-term CD rates and looks like a great return, especially so in Hawaii where 3-4% is much more common. A "good return" could vary from 3% in 2003 (when the Fed was only charging about 1%) to 15% in 1981 (when you could get about 13% in Treasuries), not that you could get financing for that kind of rental investment. And of course the real estate gurus would have you screen hundreds of opportunities with innovative financing until your return is north of 10% no matter where or when.

The best cash-on-cash return beats other lower-risk opportunities (like CDs) with a long-term tenant and zero phone calls.

Anyone know of a spreadsheet for calculating cash-on-cash returns of properties that you've owned for over a decade and formerly used as a primary residence?

 

[Meadbh]

Cash on cash return - Wikipedia, the free encyclopedia

This explains why "it depends".

 

[CybrMike]

I'm doing a very large deal at the moment, ~$2.3M purchase price. My COC return is going to be in the neighborhood of 10%, but the upside potential could take the COC to 25%+ within a few years, otherwise I wouldn't be interested in the deal.

For smaller rentals, I wouldn't touch it for less than 10 - 15% COC return. Although YMMV, I am in the midwest, Indianapolis.

 

[Nords]

For smaller rentals, I wouldn't touch it for less than 10 - 15% COC return.

I told a Hawaii RE property manager that once and she laughed so hard she had to put the phone down to recover...

 

[CybrMike]

Yeah, for me, its just not worth the effort for less than 10 - 15%, but in many areas that isn't feasible. I'd stay out of the market in those areas and stick it in a CD, MM, muni-bond, something else where I don't have to actually "work" to earn the return.

 

[clifp]

I told a Hawaii RE property manager that once and she laughed so hard she had to put the phone down to recover...

Wow people actually get positive cash returns on rental property

Having spent my adult life in California and Hawaii, I assumed that rental properties only had a negative cash flow.

 

[Arif]

I calculate cash on cash a little different since most of my property are bought at a discount. I include not only the rental income but the equity as well so the formula would look something like this:

Annual Income+Equity/Cash Invested

I normally look for atleast a 50% coc return on each investment.

 

[Darryl]

Never forget when we were considering buying a bar many years ago. RE agent asked what kind of return we needed to make the deal work and I said 100% annual ROE and she nearly fell down. We were making that on rentals at the time with almost no w*rk. Uh we didn't buy the bar.

 

[Letj]

I never buy rental property unless I can get a minimum of 20% cash on cash return. For low income property, I would not touch it unless it was at least 30% (in reality it's greater than 50%). I must add that I own 8 rental properties and I have less than $40K of my own tied up so understandably my coc return is quite high.

 

[DollahBillYall]

What sector on earth could you possibly get that COC?

DBY

 

[tryan]

Yeah, I won't touch a rental property unless I can see 20% COC. That's WITHOUT any assumptions of appreciation.

Anything less and you're setting yourself up for a negative cashflow; simply too many unknowns (vacancies, repairs, evictions .....).

What sector on earth could you possibly get that COC?

Nearly impossible today (unless your in the middle of foreclosure-valley e.g. Detroit). That's why I've been a seller for the last few years.

 

[DollahBillYall]

Strictly speaking the COC = Annual Return (- Net Operating Income)/ Downpayment.

Tax advantages, both active and passive can be factored in to boost the COC significantly. Are you all talking about COC before or after active and passive gains are factored in?

O0
(I talk big)

 

[tryan]

Before ... if you're gonna factor in assumptions about future appreciation i.e. "after", you'll be better off writing fairy tales for childern's books.

If you've already purchased the property COC is a mute point (nice exercise, but of little value predicting future returns/apprerciation) .... we're triing to qualify a new purchase.

 

[Letj]

What sector on earth could you possibly get that COC?

DBY

I am in the Virginia but the COC is higher because we manage them ourselves. Would probably be much lower if we used a property manager who is likely to be less fiscally responsible with our money.

 

[DollahBillYall]

Before ... if you're gonna factor in assumptions about future appreciation i.e. "after", you'll be better off writing fairy tales for childern's books...

Mah man, I'm factoring wha's REAL not future, baby. If I offset my annual return - (net operating income) - (operational losses) on my tax return, I save being taxed on the offset portion by my tax bracket. That's not an assumption. For example:

+13,000 $ - gross rental receipts
-6,500$ - mortgage on rental property
-1,300$ - operational losses (repairs, etc.)
--------
NOI = 5,200

$7800 of gross rental receipts would be offset by active losses. If you are taxed at 28%, you are saving $2184 in taxes by investing in income producing real estate.

Therefor, your true cash on cash is 5200 + 2184 = 7384$

If your down payment was 50k, your true COC would be 14% compared to
10% before entering the tax savings calculation. AND this is not even counting in passive losses (as they are phased out based on income level).

No fairy book there!

O0

 

[tryan]

... I see what you did. I don't factor in the tax bennies because my bracket fluxuates too much (depending on sales). But if your income is stable (rents/day-job), what you did makes sense.

What I was refering to was "cooking the books" by assuming X% appreciation/year to find a way into the purchase. Lots of newbies want to assume price appreciation .... "why else would you buy"?

p.s. I like the mortgage to income ratio you show (<=50%) ... another nice metric for qualifying a rental.

 

[DollahBillYall]

...

p.s. I like the mortgage to income ratio you show (<=50%) ... another nice metric for qualifying a rental.

Oh yeah, thank you for giving me that pearl! Much appreciated.

 

[tryan]

yeah, if your COC is 20% (or greater) and the mortgage in income ratio is 50% (or less) ... that doesn't leave too many ways you can screw it up.

Unless of course, you put some dead-beats in the unit who baracade themselves in and refuse to pay rent.

I expect people will say "there's no freak'n way I can purchase property in my neighborhood using those guides" ... that's why I've been a seller the last several years.