Do you include rehab costs in COC returns?

Question

I typically view the rehab cost as a separate bucket as my downpayment.   For COC I typically look at how much I put down, and then divide my net returns against that downpayment.  I don't include the rehab costs as I typically view that as in the "equity bucket," in the sense that those dollars increased equity value or at least built a turn key product with little to no equity.  If I included my typical rehab costs as part of my COC returns everything could be negative.  Just curious if this is standard, or are any of you able to create positive cash flow within 2 years with rehab budgets over 15-30k?

Conner Olsen · Answer

Yes I believe you should but I would not just consider CoC but include increased equity, ROI (include sweat equity), and look into CoC after refi. If you just went by CoC the only properties that would look good are ones you never update or ones just fixed up/new build.

Sergey A. Petrov · Answer

If you are holding and renting, you refi once the rehab is done, pull your cash back out and it is no longer part of the equation since the cash is back in your pocket. If you flip and sell within 2 years, you’d certainly want to be positive.

At the end of the day, coc is just a metric. The more cash you have tied up in a property (whether it is a rehab or a higher downpayment at acquisition) the less your coc but your cash flow might be higher. No one metric defines overall performance of an investment. I look at a combination of net income and value

Gregory Schwartz · Answer

@Amir Navabpour I like to think about it like this, if a silent investor was the money guy and all the funds came from him, then he would want to know what the return is on his investment. Whether that money went toward rehab, downpayment or property management does really matter. Money in is money in and money out is money out.

To make it easier I try to have all the funds (down payment, rehab and contingency) up front and in the checking account so that we aren't constantly making owner contributions.

JD Martin · Answer

Yes. I count everything that it costs me to buy that property on the front end. And going forward I count everything hard that it costs me to keep the property.

Amir Navabpour · Answer

@Conner Olsen very helpful perspective, thank you

Amir Navabpour · Answer

@Gregory Schwartz yeah you nailed it.  The more time goes by the more I come to the conclusion this is a long term game and freezing returns at a point in time like 1, or 2 years in doesn’t mean much.  My goal is to grow net worth while having moderate cash flow. Most of my total returns have come from appreciation which I consider paper gains. I’d bet some of those paper gains have been wiped out in the last 2 months as rates have gone up. I currently have 13 SFR’s.  My plan is to get to about 20, have about 10-12 of them fully paid off in 5 years. My ultimate goal is to do a hybrid. Have a portion of my portfolio I carry debt on for long term appreciation/equity pay down, while I get enough income to give me options. Not sure full blown financial freedom is realistic but options

Allan C. · Answer

@Amir Navabpour treat rehab costs no different than down payment. Ultimately it becomes the numerator (ie total capital employed) when determining your return on capital. You don’t net it out of your free cash flow from an earnings perspective, but it does eat into your CF from a practical perspective.

Gregory Schwartz · Answer

@Amir Navabpour my cash on cash is extremely low initially. And I'm learning the hard lesson that I need to raise/set aside a larger amount of funds for deferred maintenance.  For example, I purchased 3 fourplexes and set aside 50k for upgrading units and capital expenses. What I didn't account for was 6 water heaters eating up $7800 worth of what would have been cash flow.

To combat this I like to focus on 5-year annualized returns. The equity growth from upgrading my units and driving rents has been the most significant contributor to the ROI not so much the cash flow. If I can avoid being cashflow negative on operating expenses for the first 2 years while I stabilize the property then I consider that a win.

Its all about your goals. Are you chasing financial independence where cash flow is king or do you track net worth where you will see the majority of your gains in the form of equity?

Amir Navabpour · Answer

@Gregory Schwartz helpful. With this all inclusive approach I would be curious to see an example of a typical deal you’ve done. What I’m struggling with on this definition of COC is how it’s mathematically realistic to show a positive return within two years.

Amir Navabpour · Answer

@Sergey A. Petrov have you actually produced a positive cash on cash return within two years? I don’t see how it’s possible to generate enough cash flow to be positive when the typical rehabs I’ve come across are 20-30k

Do you include rehab costs in COC returns?

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