Cash on cash returns in real estate investing.
I am a very simple person and use basic principles in all facets of life and business. Wanting to find a more elementary way to evaluate I started looking at the very basic numbers on a potential investment property purchase. I believe the 30-year fixed loan to be the greatest asset in a transaction (watch for December for this explanation), so I figured no simpler instrument to start with. Let’s apply some straightforward math and see if this makes sense to more than just me. We will start with the following assumptions as a baseline (based on a loan I am presently working on for an investor in Kansas City with Bridge Turnkey Investments):
- $104,950.00 acquisition price
- $20,990.00 initial investment (20%)
- $83,960.00 loan
- 1% rent to value ratio = $1,049.00 (actual rent is higher)
- $5,500 in approximate settlement (title fees, lender fees, taxes, insurance, inspections, appraisal, etc. actual expenses are lower)
- 8% property management fees
- 568.11 PITI (based on locked rate of 4.75% and 5.003 APR)
- $396.97 per month cashflow NOT counting maintenance and vacancy
Looking at this example, I will ask many investors how much money they spent at closing. Often the sum of $26,490.00 is the provided answer. I beg to differ…Is the $20,990.00 really spent? The $5,500.00 went to services, but the $20,990.00 went from a liquid account to a non-liquid asset. It is still theirs, just not in a place they can readily convert into a boat. With regular rent coming in and regular payments to the loan being serviced, the $20,990.00 becomes $104,950.00 as the initial lien is diminished by income from the tenant. That is an $83,960.00 gain just on the amortizing of the loan. Divide that by 30 years you get an average of $2,798.66 per year which is equal to 13.33% of the initial 20% added to that $20,990.00 every year until you reach $104,950.00 total.
So, let’s shelf that part of the return and turn our attention to the money that was actually spent — the $5,500.00. Using the $396.97 per month, it is possible to recover the spent $5,500.00 in 13.85 months. At that point, an investor has broken even. Since 30 years is equivalent to 360 months and the first 13.85 was used to recover the spent funds, 346.15 months are open opportunity for cashflow.
Receiving $396.97 per month for 346.15 months will yield $137,447.16 in income. Add that to the $83,960.00, and the actual dollar gains are $221,407.16. That is all without factoring in rent raises, tax benefits, appreciation or paying payments with future dollars effected by inflation! I know what you’re thinking…What about maintenance and vacancy? Watch for the November/December issue of Think Realty Magazine for the answer!
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