Cash-on-cash return AFTER the first year?

Question

I'm trying to find a calculation to help me compare a rental investment property to a stock / mutual fund investment. I've read that rental property CCR can be directly compared to annual return % of a stock investment, but it only applies to the first year of ownership. What can I use after the first year to accurately compare?

Account Closed · Answer

@Brian C. That is correct. The way I think about it, I invested a sum of money say X. After expenses I get Y back. I have a choice of what to do with the Y. I can reinvest it all in the same investment (i.e pay the mortgage), or take it all out (if I had a interest only loan) or anything in between. So to make a fair comparison I just look at Y/X as that years return. Now because you reinvest in the mortgage, you have the effect of compounding your money which is the huge advantage of leveraged RE. If I paid cash for the house, I get the cashflow in my hand but then I have to find another place to invest it to keep it growing. So while I am in the asset accumulation phase of my life, I keep compounding. When I stop working and use the cash flow to live on, then no more compounding.,

Account Closed · Answer

You wanted to compare to other investments. If you think about stocks, think of principal pay down as a re-invested dividend. Your invested amount is always the initial investment. There is another measure called ROC or return on capital. In that case you can add the principal paid down to the denominator. In that case your return in future years will actually go down until the loan is paid off at which time it will equal the cap rate. But I look at it the first way. Its more meaningful and allows comparison with other asset classes.

Account Closed · Answer

@Brian C. Thats not how you do ROI. So using sample numbers. Lets say a house is $100K. You put 20K down plus 4K closing costs. So your total cash in is $24K. That always remains the denominator for the calculation. In the first year lets say your cash flow as $200/month or $2400 per year. Lets also say you amortize your mortgage and paydown principal by another $2000. So your total earinings are $4800. Your ROI is 4800/24000 or 20%. The next year you may still make 2400 in cash flow but you pay a little more principal down. So your ROI goes up a little but it doesnt double. As you get closer to the end of the loan, your ROI starts to go up more rapidly. Does that make sense?

Account Closed · Answer

20% ROI in the first year is definitely doable with a 4:1 or 5:1 leverage. But why does it double in the second year? I dont factor appreciation in the return numbers but I do include principal paydown.

Bryan L. · Answer

@Brian C. I'm not sure what you mean by "aggregate cash-flow", but I think that you should be looking at your annual cash-flow versus your equity. That number will give you something that can be compared to the return on a bond, CD, annuity, or whatever. But hey, maybe I'm wrong.

Bryan L. · Answer

Instead of cash-on-cash, look at cash-on-equity returns. If you were to sell that rental, pay Realtor's commissions, closing costs, etc, how much would you walk away with? Say for example it might be $20,000. Now, if you have positive cash-flow of $1800 per year with the rental, plus $200 per year in income tax savings due to the depreciation, you are making a 10% return on your equity. Use this number to compare to stock market or other investments.

Jordan Thibodeau · Answer

Aggregate cash flow( first month - current) / Cash invested (down payment ,closing costs + equity build up). You could add appreciation but it would be tricky at times, that's best used when you sell.

Brian C. · Answer

So principal paid is considered earnings? I was considering it cash invested.

Sylvia B. · Answer

Because percentages can be figured so many different ways - as this thread demonstrates - I prefer to look at actual dollars instead. I know it's not "how it's done" but my pocket doesn't know squat about percentages, it only holds cash. ;-) So $20,000 in my bank will get me about $30 in interest for a year. A good CD might pay $300. A mutual fund could make $2500. If I put that $20k into down payments on rental houses that cash flow $6000/year I have an excellent investment, and I don't care what the percentages are.

Brian C. · Answer

Ok, I think I got it now, thanks for helping out a newbie. So the ROI/CCR goes up slightly each year because you're paying less interest / putting in more principal. Initially my equation was showing a decreasing CCR because my denominator was getting larger (principal payments) while the numerator increased only slightly (decreased outflow of cash due to smaller interest payments).