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Updated about 1 year ago, 10/27/2023
ROI increases as amount down increases? Where is my analysis flawed?
Hi gang,
Been away for awhile. Retired about 3 years ago and have been living the dream on my passive real estate income. :)
I recently sat down with a friend to help them analyze their first SFH rental investment. During the analysis I came up with the surprising result that the Cash-On-Cash ROI got better the more money we put into the investment. This result goes against everything I have ever heard (or believed) about real estate investing.
Here's the deal. (It's not a good deal, but all the deals are bad these days.)
Price: $153,000
Mortgage Rate: 8%
Rent: $1195
Fixed Expenses (management, repairs, tax, insurance, etc.): $468/mo
Here is my spreadsheet. I am calculating CoC ROI as (yearly net / down payment). I've checked many of these numbers by hand, and had my wife build her own spreadsheet to double check. She came up with the same results. So I don't think there is a math error.
What am I missing in my analysis?
I'm sure I'm having a senior moment and am doing something dumb. I look forward to having you all 'splain how dumb I'm being. (Thanks in advance.)
| %Down | Down | Mort | Cash Flow | CoC ROI |
| 0.00% | $0 | $1,122.66 | -$395.26 | * |
| 5.00% | $7,650 | $1,066.53 | -$339.13 | -53.2% |
| 10.00% | $15,300 | $1,010.39 | -$282.99 | -22.2% |
| 15.00% | $22,950 | $954.26 | -$226.86 | -11.9% |
| 20.00% | $30,600 | $898.13 | -$170.73 | -6.7% |
| 25.00% | $38,250 | $841.99 | -$114.59 | -3.6% |
| 30.00% | $45,900 | $785.86 | -$58.46 | -1.5% |
| 35.00% | $53,550 | $729.73 | -$2.33 | -0.1% |
| 40.00% | $61,200 | $673.60 | $53.80 | 1.1% |
| 45.00% | $68,850 | $617.46 | $109.94 | 1.9% |
| 50.00% | $76,500 | $561.33 | $166.07 | 2.6% |
| 55.00% | $84,150 | $505.20 | $222.20 | 3.2% |
| 60.00% | $91,800 | $449.06 | $278.34 | 3.6% |
| 65.00% | $99,450 | $392.93 | $334.47 | 4.0% |
| 70.00% | $107,100 | $336.80 | $390.60 | 4.4% |
| 75.00% | $114,750 | $280.66 | $446.74 | 4.7% |
| 80.00% | $122,400 | $224.53 | $502.87 | 4.9% |
| 85.00% | $130,050 | $168.40 | $559.00 | 5.2% |
| 90.00% | $137,700 | $112.27 | $615.13 | 5.4% |
| 95.00% | $145,350 | $56.13 | $671.27 | 5.5% |
| 100.00% | $153,000 | $0.00 | $727.40 | 5.7% |
Ugh... that spreadsheet was formatted much more nicely before I hit the Post button. Sorry.
That's what happens when interest rates are at 8% and purchase price/gross yields haven't adjusted.
The gross rental yield is only 9%, coupled with expenses it's less than the cost of financing - hence you earn yield by removing the cost of financing with cash.
High rates encourage this kind of behavior (holding cash or using cash to cut interest expense). The market hasn't adjusted yet, liquidity will come out, prices will come down, or rents will go up....or some combination of all three to make pricing work. Right now it doesn't.
Quote from @George Pauley:
Hi gang,
Been away for awhile. Retired about 3 years ago and have been living the dream on my passive real estate income. :)
I recently sat down with a friend to help them analyze their first SFH rental investment. During the analysis I came up with the surprising result that the Cash-On-Cash ROI got better the more money we put into the investment. This result goes against everything I have ever heard (or believed) about real estate investing.
Here's the deal. (It's not a good deal, but all the deals are bad these days.)
Price: $153,000
Mortgage Rate: 8%
Rent: $1195
Fixed Expenses (management, repairs, tax, insurance, etc.): $468/mo
Here is my spreadsheet. I am calculating CoC ROI as (yearly net / down payment). I've checked many of these numbers by hand, and had my wife build her own spreadsheet to double check. She came up with the same results. So I don't think there is a math error.
What am I missing in my analysis?
I'm sure I'm having a senior moment and am doing something dumb. I look forward to having you all 'splain how dumb I'm being. (Thanks in advance.)
| %Down | Down | Mort | Cash Flow | CoC ROI |
| 0.00% | $0 | $1,122.66 | -$395.26 | * |
| 5.00% | $7,650 | $1,066.53 | -$339.13 | -53.2% |
| 10.00% | $15,300 | $1,010.39 | -$282.99 | -22.2% |
| 15.00% | $22,950 | $954.26 | -$226.86 | -11.9% |
| 20.00% | $30,600 | $898.13 | -$170.73 | -6.7% |
| 25.00% | $38,250 | $841.99 | -$114.59 | -3.6% |
| 30.00% | $45,900 | $785.86 | -$58.46 | -1.5% |
| 35.00% | $53,550 | $729.73 | -$2.33 | -0.1% |
| 40.00% | $61,200 | $673.60 | $53.80 | 1.1% |
| 45.00% | $68,850 | $617.46 | $109.94 | 1.9% |
| 50.00% | $76,500 | $561.33 | $166.07 | 2.6% |
| 55.00% | $84,150 | $505.20 | $222.20 | 3.2% |
| 60.00% | $91,800 | $449.06 | $278.34 | 3.6% |
| 65.00% | $99,450 | $392.93 | $334.47 | 4.0% |
| 70.00% | $107,100 | $336.80 | $390.60 | 4.4% |
| 75.00% | $114,750 | $280.66 | $446.74 | 4.7% |
| 80.00% | $122,400 | $224.53 | $502.87 | 4.9% |
| 85.00% | $130,050 | $168.40 | $559.00 | 5.2% |
| 90.00% | $137,700 | $112.27 | $615.13 | 5.4% |
| 95.00% | $145,350 | $56.13 | $671.27 | 5.5% |
| 100.00% | $153,000 | $0.00 | $727.40 | 5.7% |
Our economy has been humming with close to zero interest rate for too long that many of us have forgotten how things work on the flip side. The idea that COC always gets better as you put down less on an investment (classic leverage) generally holds true in a low interest rate environment, especially in the "artificially" low interest rate environment created by the Fed. Well the Fed changed all that and they changed it in a hurry, catching a lot of us by surprise. Your project pays 6%, if you finance it with 8% int rate then the COC behavior that you observed is expected. Every dollar you put down replaces a dollar of mortgage costing 8% with 6% of profit. That's why your COC goes up as you put down more.
So the answer is we are operating in a flipped environment, profit is low interest costs are high. So it would make sense that COC behavior is flipped as well. Bottom line, your and your wife's spreadsheets are probably just fine :-)
Cheers... Immanuel
I have been noticing a bell curve of COCROI where the more cash flow we have, the more skewed left it is, and the less cash flow we have the more skewed right it is. Ill post my equations from DESMOS once I hone in some more variables.
According to your worksheet, the best return you can get is 5.7%. Tbills are paying 5.6% this is the world we live in now. Its crazy.
It's funny how situations change. 5 years ago I would have been laughing too hard at this deal to tell the seller "NO!". Today I'm retired and the idea of getting 6% on $150k AND depreciation AND rent and price appreciation AND having it in tangible property instead of dollars actually seems pretty attractive. If my buddy doesn't take it, I just might. :)
Quote from @Austin Laramee:
I have been noticing a bell curve of COCROI where the more cash flow we have, the more skewed left it is, and the less cash flow we have the more skewed right it is. Ill post my equations from DESMOS once I hone in some more variables.
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#5 Investor Mindset Contributor
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The term for this is "negative leverage"...when the the interest rate on debt is higher than the cap rate. At some point, interest rates and/or prices have to adjust down because there is little reason to invest in assets and every reason to invest in debt.
Should use IRR instead of CoC ROI to capture principal pay down and appreciation (along with cash flow).
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@George Pauley there is 2 things your missing.
1st is tax. Net cashflow is taxable income. Impact of this varies and is specific to specific owners situation, but in general that will diminish what "true net" a person is getting.
And since we are talking in a scenario of let's say putting $100k down on a property vs $200k, for said expanded cash-flow, that is a calculous to measure in. Because if the vs in $200k down on 1 property, vs $100k down on 2, with the 2 your getting more tax unrealized returns via tenant paid debt paydown, appreciation etc..
Again, it varies a lot in tax's impact very specific to the specific person and there situation, so one must do analysis specific to them to find out exactly what the weight of that impact is.
2nd is the life positioning, if one's needing to GROW a portfolio, or in the post-growth phase which I call "Dividend Time".
By the math, if the "average" person with an "average'ish" income set's out wanting to create passive income and is going to focus on LOW leverage and cash-flow to do it. On average over 20/30yr lens they may achieve "as-much-as" 3-4 investment units. And yes, enjoying that cash-flow but....
On the alternative, the same person uses strategic measures and planning, to START with leverage phase, focusing in appreciable gains and $ flipping, will in same time be sitting upon an average ~20-30 units.
With the strategic evolution plan it's a 1st phase of growth, getting asset's under control UP, strategically utilizing leverage and other actions, with cashflow focused solely for operational coverage. At than "flipping the switch" too consolidation, selling off portion of portfolio to reap gains, to either pay down debt on chosen remainder of say ~10 unit's too $0.00 thus "turning-on" the "cash-flow-machine" from those remainder 10 units.
OR, reaping the full capital of all, and deploying into a singular centralized MFH unit to than enable staff to run ALL day-2-day and really truly be hands-off/passive. And in that "retirement" MFH property, having low leverage and size of unit that it makes sense to have staff to run entire operation.
So the big factor your analysis does not show is TIME and GROWTH, what growth is enabled by such in what time frame. LEVERAGE is the magic-wand for maximum growth potential, in shortest time duration.
Sure, we could all become millionaires doing the Ramsey method of only buy in cash, if we had 325yrs to live. Most have 10/20yrs to build a portfolio, and that necessitates leverage to maximize potentials.
In growth equitable gains are king, in "retirement" phase it flips too cash-flow.
- James Hamling
I would not touch it, 150k (plus repairs) with rent only 1200, nope. Rent needs to be at least 1700 IF the all in costs are 150k. I just picked up 7 all under 100k, all with rents from 1200- 1400,
All the best