There are so many different calculations that are thrown around when you are investing or are thinking of investing in real estate.
I remember researching for hours trying to figure out which one I should be using and what they meant.
So I get it, because it’s hard to know which one to pay attention too, or more, which ones not too.
Over the years I figured out there are only a select few that I really pay attention too, and one of those is the cash on cash return.
I’ve talked before about this calculation in this video here;
'What is a Cap Rate', however, I never went into depth about what would be a good cash on cash return when investing in real estate.
In this video below, I will, so watch until the end to learn more about this financial calculation AND the benchmarks I use to determine what would be a good cash on cash return for an investment property.
Yeah, everyone ALWAYS wants cash flow when investing in real estate.
Before we dive into what and how the cash on cash return financial calculation works, I should clarify for those learning about investing in real estate what the term, cash flow means that everyone talks about.
In simplest terms...
It’s the profit, what is remaining from your income, the rent you collect, after paying your expenses, your mortgage, your costs you incur at your property.
This is the money that you are basically putting in your pocket each month.
This is why so many investors love cash flowing properties, because you are making money NOW!
However, just because the property cash flows each month, this doesn’t always mean that it’s a good investment.
In fact, over the years, I’ve seen tons of properties where in the description of the listing, it details the income and the expenses, and then you read that it’s a great cash flowing investment, and right away you start thinking of buying the property.
However, I’ve learned to tell myself, ‘not so fast’, because by applying the cash on cash return financial calculation, you can get a more thorough understanding if the property REALLY is a good cash flowing investment.
For instance, I get asked all the time "what’s a good cash flow on a property"?
Many, including myself at one point and time thought $100 a door was great.
However, let’s say you’re looking at 2 duplexes.
One priced for $300K that you project cash flows $100 per door, the other, priced at $200K, projects a monthly cash flow of $75 per door.
If you were to think in terms of the monthly cash flow amount, you’d automatically think that the $100 is better.
But when applying the cash on cash return calculation, in which you take the annual cash flow and divide it by the cash investment you made into the property, the property that cash flows only $75 per month is the better investment, as the percentage of cash flow to your investment, your cash on cash return, which in this example, is just your down payment amount to keep it simple, is higher.
4.5% for the $200K property, compared to 4% for the $300K property.
This is why you can’t just use a simple benchmark of $100 cash flow per unit.
You need to measure your cash flow against the cash you invested, to really determine which property will provide the best return.
Now, in my example it was probably obvious that the $75 dollars per month would be the better investment.
However, if you were to start factoring in possible renovations that a property would need, that in essence is additional cash you are investing, which will then affect your cash on cash return.
For example, if we project the $200K property also needs $20K in renovations, now the $300K property becomes the better investment.
This is one of the biggest mistakes investors make, in that they will buy the more affordable property, and then have to dump more money into it to get it up and running, and most of the time; and I’ve been guilty of this, we end up putting even more money into the property, which then greatly affects your cash on cash return and you would’ve been better off buying the more expensive property.
This is why I preach that when you invest in real estate, it really is all about the numbers.
Now you’re probably wondering, is that a good cash on cash return to achieve?
This was one of the biggest hurdles I faced when I started, because no one anywhere ever told me what would be a good cash on cash return.
It took many years of investing in real estate, and analyzing thousands of properties, to develop benchmarks of the cash on cash returns I look for in a property I’m considering purchasing.
For instance, when fix and flipping properties, I always try to get a 100% cash on cash return on my investment.
When using the buy and hold strategy, if it’s a newer property with not much maintenance required and rents are at the market rate, I try to get a 10% cash on cash return.
If however, the property I’m looking to purchase to hold as a rental, and it needs some TLC and the rents are below market, I want to make sure I get at least a 5% cash on cash return upon purchasing it, this way I put a bit of cash in my pocket, enough to cover all my costs with a bit of a buffer, until I can improve the property a bit and get higher rents, with the goal being to increase my cash on cash return to 20%.
In fact, I talk more about this strategy, which I call the BHIIR strategy, in this video here; how to build wealth in real estate FAST.
WHAT TO DO NEXT:
If you want to learn about all the benchmarks I use when investing in real estate, and even the spreadsheets I use which instantly will calculate the cash on cash return financial calculation, among the others I use, which I talk about in this video here, just click on the picture below this video to access my Fast Investing Roadmap.