Cash Flow Returns.

[GaryMcGowan]

I`m looking for some feedback here.

If an investor is to invest for Cash Flow first then appreciation; what return are you looking for per year?
If you invest 75k into a property what do you expect to get in return (cash flow) otherwise known as the "cash on cash return"?

I have polled our investors and I will share what they have said after I see some response.

 

[housingrental]

Hi Gary
10%.. however my experience has been that a good chunk of investors I`ve met try to target at minimum 5% cash on cash return potential - however with the idea that mortgage pay down and appreciation will also happen.

 

[Thomas Beyer]

QUOTE (GaryMcGowan @ Jul 25 2010, 05:54 PM)
I'm looking for some feedback here.



If an investor is to invest for Cash Flow first then appreciation; what return are you looking for per year?

If you invest 75k into a property what do you expect to get in return (cash flow) otherwise known as the "cash on cash return"?



I have polled our investors and I will share what they have said after I see some response.




It is one thing to state what you want. Everyone wants high returns. The only thng that matters is what can you realistically deliver given the asset class and the market !!



5-7% is doable if you are not too levered .. What they want is another story.



In the current economy anything over 5% return with low to no risk is very good !!!

You go over 8 or 9% the risk goes up !



Investors can either buy equity (i.e. a share of profit with an unknown return) or debt, i.e. a loan secured by real estate (in 2nd position behind a 1st mortgage usually).



For a fixed ROI investor the latter option may work, as for the real estate expert. Then you may offer more than 5 or 7% IF (and only IF !!) you are confident in the market over a 5-6 year horizon, as you'd keep 100% of the equity. This is more risky to the expert as you may end up with 0 if the market doesn't perform as envisioned.



[as an fyi: In our business model, syndicated apartment buildings, we can deliver 4% / year just on the mortgage paydown alone, not counting any equity upside or cash-flow. How likely is it that there is no equity upside in 5 years: possible of course .. but not very likely .. so with 30% down and perhaps a 20% upside over 5-6 years you can do 20/30 i.e. 66% (minus our equity share) plus 4%/year. This assume a very sloppy purchase and very sloppy / average management over 5 years. Usually we do better.



In houses where cash-flow is usually poorer the math will be different but run the math based on various assumptions and you'll see what can be delivered: about low double digit]

 

[gwasser]

QUOTE (ThomasBeyer @ Jul 26 2010, 09:38 AM) It is one thing to state what you want. Everyone wants high returns. The only thng that matters is what can you realistically deliver given the asset class and the market !!

5-7% is doable if you are not too levered .. What they want is another story.


I guess, I am a bit more agressive.

From a non leveraged real estate or stock market investment - long term I expect a 10-12% return per annum.

From MIC`s I want at least 8%; less I won`t touch.

Leveraged real estate requires an annual return of 15 to 22%

Passive JV`s depending on risk level and LTV (experience of operating or active partner, investor exposure to mortgageg liability, operating liability, etc) 15% to 30%.

With debt obligations from major banks I am willing to go as low as 6% with inflation protection and less than a 5 year maturity. Higher risk corporate obligations I want at least 10% plus the chance of significant appreciation.

If you think that that is unrealistic, you may be right but those are my criteria. What I will end up getting in the real world is of course a different matter. Overall, though, if I can`t get returns like that in this market, why bother?

I don`t look at only the cashflow component of an investment. I only am concerned with ROI and minimum positive cash flow (i.e. $100 per month per door). In terms of cap rates, my minimum is 4% - that would mean that with zero leverage I expect as a minimum 4% net cash flow.

 

[Thomas Beyer]

QUOTE (gwasser @ Jul 26 2010, 11:08 AM)
...



Leveraged real estate requires an annual return of 15 to 22%



Passive JV's depending on risk level and LTV (experience of operating or active partner, investor exposure to mortgageg liability, operating liability, etc) 15% to 30%. ..


That used to be quite doable from 2000 to 2007 .. but 2010 forward this will be difficult to achieve .. not impossible but very difficult !

 

[gwasser]

QUOTE (ThomasBeyer @ Jul 26 2010, 05:13 PM) That used to be quite doable from 2000 to 2007 .. but 2010 forward this will be difficult to achieve .. not impossible but very difficult !

We will just have to wait and see how real estate will stack up against other investments. The `new` world of greying populations, deleveraging and declining consumerism may look quite different from past investing environments. Neither do we know whether the critical attitudes regarding the environment will persist (e.g. resistance against new oil pipe lines from Alberta to the West Coast or opposition to NE Alberta`s heavy oil). How will we fare in a world of high oil prices and limited economic growth?

There are currently too many uncertainties at the horizon to identify major investment and economic trends. We`re living in an energy revolution and although we have a low inflation environment, investors may feel that current risks do not warrant low returns and they may decide to rather stay in cash. It seems that cash will be king again and with a possible deflation scenario, just holding cash may be the best way to ensure you`ll retain your purchasing power.

I have been selling questionable investments, i.e. those that will only perform under optimum circumstances or whose investment story has gotten muddled and unclear. I tried to offset capital gains with losses in order to reduce taxes and preserve cash. This is the time to get rid of dogs and build up cash for upcoming opportunities.

2nd Quarter earnings reports are, in my opinion, quite decent and a second recession (double dip) is not likely. But the `wall of worry` we`re currently climbing is steep and big; one misstep and... So this is not a time to take risks - I`ll be waiting to see what happens in September and October. Knowing myself, the real problem will be `being able to restrain myself` and not to spend my cash too early in the game. So, unless I see the returns I want, there won`t be any movement. I suspect many other investors think similarly right now - hence we`re in this nasty trading range.

I will insist on the previously listed returns otherwise, I`ll prefer to hold on to cash until the skies clear. In other words, it`s my way or the high way for those who want my investment dollars.

 

[GaryMcGowan]

Thanks for the insight,
As mentioned by Thomas, What someone wants and what is realistic needs to be discussed when having this conversation with Investors.

In my conversations over the last 6 months people have mentioned they would accept anywhere from 5% to 10% COC return. It also depended on who I was talking to. Is Cash today important to them or not. Meaning do they need it for daily living.

Our partners have been receiving approx. 8-11% for COC. To put it into context we primarily are only buying Rent To Own properties which allow us to really nail down a return (with all things considered). We calculate COC by the following.

Investment Includes, All closing costs, 2 Month Reserve Fund, Inspection, Appraisal, etc.,

Yearly Lease Payment
Subtract
Total of All Expenses >>>Total Mortgage Payment (we do not use mortgage pay down for this), Property Taxes, Insurance. (our Tenants take care of all other expenses)

= Cash Flow

Divide by ownership percentage
=Partners Cash Flow

Divide by the Total Investment
= Cash On Cash Return

 

[markl]

It depends on the investment.

A long term buy and hold will be lower 4 - 6% cash on cash return.

Rent to own return 10% range and the same with lending

Rehabbing properties 20% per year

Regards,

 

[gwasser]

QUOTE (GaryMcGowan @ Jul 26 2010, 10:10 PM)
Thanks for the insight,

We calculate COC by the following.



Investment Includes, All closing costs, 2 Month Reserve Fund, Inspection, Appraisal, etc.,



Yearly Lease Payment

Subtract

Total of All Expenses >>>Total Mortgage Payment (we do not use mortgage pay down for this), Property Taxes, Insurance. (our Tenants take care of all other expenses)



= Cash Flow



Divide by ownership percentage

=Partners Cash Flow



Divide by the Total Investment

= Cash On Cash Return




Why would you exclude property taxes and insurance from your expenses?





Does the COC include any potential appreciation or is that added afterwards when the property is bought by the Renter/owner.

 

[GaryMcGowan]

QUOTE (gwasser @ Jul 28 2010, 06:53 PM)
Why would you exclude property taxes and insurance from your expenses?





Does the COC include any potential appreciation or is that added afterwards when the property is bought by the Renter/owner.






We pay for property taxes, insurance. All other expenses are paid by the Tenant.

The COC calculation does not include any future appreciation. We do share the leftover equity as per the percentage of the ownership. This equity share of course will bump up the partners return.

 

[gwasser]

QUOTE (GaryMcGowan @ Jul 28 2010, 07:15 PM) We pay for property taxes, insurance. All other expenses are paid by the Tenant.
The COC calculation does not include any future appreciation. We do share the leftover equity as per the percentage of the ownership. This equity share of course will bump up the partners return.


So your cash on cash should be based on

Rental Income minus property taxes minus insurance minus mortgage payments divided by your down payment (and other cash paid by partners). Which is probably a lot less than 5 to 10% per year. To arrive at the rate of return you would have to add appreciation. Of course, you would have also to account for that lease payment portion that is to go to the renter`s down payment which should be either deducted from the sales proceeds or from the cash on cash.

Or do I still misunderstand your business model?

 

[GaryMcGowan]

QUOTE (gwasser @ Jul 28 2010, 11:48 PM)
So your cash on cash should be based on



Rental Income minus property taxes minus insurance minus mortgage payments divided by your down payment (and other cash paid by partners). Which is probably a lot less than 5 to 10% per year. To arrive at the rate of return you would have to add appreciation. Of course, you would have also to account for that lease payment portion that is to go to the renter's down payment which should be either deducted from the sales proceeds or from the cash on cash.



Or do I still misunderstand your business model?




Our investors simply want to know if I invest this much how do I get back every month. If our investor is a 50% partner they receive 50% of cash flow and the equity. As mentioned earlier we do not add appreciation to the COC calculation. The tenant/buyer's rent includes the monthly credits so we include this in the monthly cash flow. Appreciation, the tenant/buyer's monthly credits and initial deposit is calculated (subtracted) with the sales proceeds which will affect the final equity pay out and total return. At the end of the day our final yearly returns have been 16-20% per year. Our Rent To Own terms are from 1-3 years which means the financial commitment from the investors is the same.

 

[gwasser]

QUOTE (GaryMcGowan @ Jul 29 2010, 07:31 AM) Our investors simply want to know if I invest this much how do I get back every month. If our investor is a 50% partner they receive 50% of cash flow and the equity. As mentioned earlier we do not add appreciation to the COC calculation. The tenant/buyer`s rent includes the monthly credits so we include this in the monthly cash flow. Appreciation, the tenant/buyer`s monthly credits and initial deposit is calculated (subtracted) with the sales proceeds which will affect the final equity pay out and total return. At the end of the day our final yearly returns have been 16-20% per year. Our Rent To Own terms are from 1-3 years which means the financial commitment from the investors is the same.

Sorry to ask so much detail, but it if I did not, it is so difficult to compare results.

Now I understand that your overall return on investment is between 16 - 20%, something Thomas mentioned was doable in earlier years with leveraged real estate (and close to my own previously posted numbers). You basically pay out part of those returns in cash during the year at a rate of 6 to 10% of initial cash invested.

The advantage of your system is that investors get cash flow faster than with more traditional buy-and-hold strategies. Whether this pace of ROI can be kept up may be in question, but with real estate prices outside Alberta recovering and now some 4.5% above the previous peak (just read that in the Globe this morning) you might have a decent chance to do so.

I hope that we in Alberta are also on the verge of a more vigorous recovery but a lot depends on natural gas prices and an overall continuing recovery. Que sera, sera.

 

[GaryMcGowan]

No Problem, Thanks for asking.
For now we are only buying in Top Ten Towns (areas) in Ontario.

 

[Nir]

QUOTE (ThomasBeyer @ Jul 26 2010, 08:38 AM) 5-7% is doable if you are not too levered ..
small correction: it`s the opposite - the more leveraged you are the higher the cash on cash!

All,
I developed the following formula and shared here around 2 years ago:

ROI not incl. appreciation = {(CAP-i) /d} + i

d – downpayment (i.e. 0.1 = 10%, 0.5=50%)

i – mortagge interest

CAP – income property CAP

ROI – not including appreciation/before appreciation in this formula but does include mortgage principle payments

Please note how the down payment % affects the COC% most. if for example you can somehow put 1/2x instead of x down (through VTB, different bank, etc.) you almost doubled your ROI or cash on cash%. therefore, we cant say 10% is not possible or 20% is not possible without asking the question how much down was put.

Gary`s numbers are in line with what I see today. A Plex purchased last year generates 7.5% CAP. just add an excellent mortgage interest and low down payment and you get > 10% cash on cash for each partner. easy? no. exists? you bet.

Regards, Neil

 

[bizaro86]

I like your formula! At first glance, it didn`t look correct, so I did the derivation myself, and confirmed you are correct. (silly me for doubting.) For anyone interested, I`ve included the derivation below, at least how I did it.

Your total return is composed of two parts, the return on your downpayment (CAP*d) and the "extra" return you earn on the borrowed money where CAP rate exceeds mortgage interest. (CAP-i)*(1-d) is the amount of money borrowed, since he defined "d" as the downpayment expressed as a decimal, where 0.2=20%.

To calculate your percentage ROI, you add those two components together, and divide by the downpayment, as that`s the only cash you put up.

{(CAP*d)+(CAP-i)*(1-d)}/d

then you distribut the (1-d) in the second term

{(CAP*d) + (CAP-i) + (CAP-i)(-d)}/d

Then we divide out the "d" which cancels from terms one and three.

CAP + (CAP-i)/d -CAP + i

and then CAP-CAP = 0


so we get ROI = (CAP-i)/d+i

Which is an non-intuitive result, at least for me, but a very interesting way of thinking about return indeed. I`m not sure anyone will find the derivation interesting or helpful, but I had done it, so I thought I`d put it up here. Thanks Neil for posting this!

Michael

 

[gwasser]

QUOTE (investmart @ Jul 29 2010, 09:24 PM)
small correction: it's the opposite - the more leveraged you are the higher the cash on cash!



All,

I developed the following formula and shared here around 2 years ago:



ROI not incl. appreciation = {(CAP-i) /d} + i



Please note how the down payment % affects the COC% most. if for example you can somehow put 1/2x instead of x down (through VTB, different bank, etc.) you almost doubled your ROI or cash on cash%. therefore, we cant say 10% is not possible or 20% is not possible without asking the question how much down was put.




Hi Neil,



Thanks for the equation.



Very useful. I would like to point out some issues with ROI on cash and leverage, because with increased leverage ROI on cash does go up, but not in a linear fashion. It increases exponentially (see graph below).



Using your equation and a cap rate of 4.5% (pretty high for Calgary) and a (variable) mortage rate starting at 2%, I graphed your ROI on cash for various down payment/purchase price ratios (d=1-LTV). First I realized that with a high LTV (95%) you will need a lot of properties for it to have a significant impact on your total investment portfolio. Say you have $100,000 and your ROI on cash is a very attractive 20% with a LTV of 95%, you would need to own 10 properties (each with $10K down) to earn 20% on your entire portfolio. That is a lot of work, hassle and risk (leverage).



Secondly, if your variable mortgage rate increases from 2% to 3% (on the graph that is 'plus 1%), your ROI goes down significantly and when the rates increases further, you may get even a negative ROI on cash (and not just a little bit). If your rate goes from 2% up to 6% ('Plus 4%'), at a 95% LTV you suddenly have a negative ROI of 24% and at a mortgage rate of 7% the ROI on cash goes down to -43%,

Just trying to make life more difficult. Hope this helps.

 

[Rickson9]

Suddenly I feel oddly inadaquate and very stupid.

 

[gwasser]

QUOTE (Rickson9 @ Jul 30 2010, 10:53 AM) Suddenly I feel oddly inadaquate and very stupid.

Do you need counseling?

 

[bizaro86]

QUOTE (Rickson9 @ Jul 30 2010, 10:53 AM) Suddenly I feel oddly inadaquate and very stupid.

I wouldn`t bother with that. I can do many types of calculus and other higher level math, and I haven`t experienced a situation where that has helped me with investing.

Godfried`s chart (and Neil`s equation) show that as leverage increases, so does your cash on cash return, but it also increases your downside risk. Anyone who understands that principle doesn`t need to be able to prove it mathematically.

Michael