Cashflow Thresholds - What do you use?

Question

In my rental deal evaluation, I'm doing a detailed analysis of income and expenses per property.  I'd like to get some opinions from experienced investors on what cashflow thresholds they are looking to achieve.  Here's my thinking:

• In a higher appreciation area, I still want to see cashflow from day one to limit risk, but the total returns are more influenced by appreciation, associated rent increases and higher property values (which result in larger mortgage principal reduction and higher tax depreciation).  
• In a lower appreciation area, most of the returns are cashflow, with a lesser amount mortgage principal reduction and tax depreciation, so I'd want to see day one cashflow be higher.

I'm currently using 3.5% cash on cash return as the threshold for high appreciation deals (enough of a cushion that I can absorb unexpected issues, but low enough to be feasible) and 10% cash on cash return as the threshold for lower appreciation market deals.

I'd appreciate hearing from a variety of investors what thresholds you use to determine whether to do a deal in what kind of market.  Thanks!

Note: In my situation, I'm looking to maximize total returns over time in comparison to other types of investments.  While the cashflow short term is nice as it can be reinvested into more doors, I'm not dependent on it, and can wait for longer term returns.  I'm including down payment and rehab costs in the invested cash calculation unless I plan to refinance post-rehab, and then I'm including just the refinanced down payment.

Costin I. · Answer

@Kimber Lockhart Maybe this belongs to a different discussion thread, but I'm curious how do you calculate your C/C return. Plus, C/C ROI gives you a snapshot in time (like at acquisition) and it's likely to change every year (as your rent and  expenses will change, equity will increase, etc.). Otherwise, more complicated models, like the previously suggested NPV, IRR, DCF, MIRR are better suited.

And unless we all operate on the same parameters and formulas, to tell you I'm shooting for 2% or 20% could be completely meaningless (I know "investors" that use their Net Operating Income to calculate the C/C ROI, completely ignoring their debt expense).

We are shooting for 10% C/C ROI or $200/month for SFR or $100/unit in MF. A 3.5% return is getting close to a savings account interest, without any risk or work.

FYI - For us:

Cash flow = Rents - PITI - Operating Expenses (Property Management 10%, Vacancy 8%+, Utilities, Repairs and Incidentals, Capital Expenses fund, Legal and Accounting. etc.)

Cash on Cash ROI = Annual Cash flow / (DownPayment + Closing Costs)

or

Cash on Cash ROI = Annual Cash flow / (Equity+ Closing Costs)

And are you counting all of these expenses in your calculations?

1) Mortgage

2) Mortgage insurance (PMI or MIP) or FHA Risk base

3) Property Taxes

4) City Taxes

5) HOA (Home Owner’s Association) Dues and Fees and Assessments

6) Insurance

a) Property Hazard Insurance

b) Flood Insurance

c) Earthquake Insurance

d) Umbrella Insurance

7) Vacancy Rate (usually 8% - the equivalent to one month a year, or 5-6% if multifamily and/or if experienced, if not use 8%)

8) Utilities (you’ll have these if your tenant is not covering them and/or during vacancy)

a) Water § Sewer § Garbage

b) Electricity

c) Natural Gas

d) Propane

9) General Maintenance (usually 5%)

a) Upkeep § Landscaping

b) Snow removal

c) Repairs

d) New Appliances

10) Capital Expenditures (usually 5%, higher is the property is old and obsolete, less if fully rehabbed and all mechanicals and roof are new)

11) Property Management (8%, even if you self manage, your time still has value and there might be a time when you'll want to be completely hands off or you'll not be able to do it, vacation, retirement, etc.), including...

a) Office Supplies (e.g. stamps, envelopes)

b) Software

c) Gas/Mileage

d) Advertising + Payroll

e) Concessions

f) Lease loss

g) Lease renewal fees

12) Lawyer/Law office/Legal fees

13) Accounting/Bookkeeping/CPA/Tax preparer/Tax advisor

Kimber Lockhart · Answer

I am currently focused on SF East Bay (where 10% COC is very difficult) and TN outside of major metro areas (where 10% COC is absolutely feasible).  I am also considering adding a middle market -- I invested in Nashville a few years back before it got frothy.  Each market has tradeoffs, and I'm debating the right balance.

@Kenneth Garrett Agreed COC is unlimited if you don't leave much cash in and have reasonable cashflows.  I've looked at a couple of deals that could look like this.  On your buy and holds, assuming you don't have any cash in after refi, how do you determine how much cashflow is sufficient?

I'd love to hear from others to learn more about how you think about Cashflow/ROI per market.  Thanks!

Kenneth Garrett · Answer

I agree with @Nathan G. appreciation is a bonus.  I do not rely on it.  Typically I use private funding and during rehab I am able to force the appreciation. I usually use private funding for my deals and refi the buy n holds out.  This provides for very little out of pocket cash. COC is usually infinite.  During the times where I need to put money in it is generally well above 10%.  Not sure if you invest in California @Kimber Lockhart or elsewhere.  Every market is different and changes the COC and ROI.

Account Closed · Answer

@Kimber Lockhart we invest solely in Oakland and our benchmark is $500/month/door, which is generally around 20% COC.

But lately I’ve been focusing on IRR, getting that above 30%, which is easily attainable with value-add BRRRR multi-family.

Dennis M. · Answer

Yeah I’d be more worried about cashflow than appreciation any day of the week . Banking on Appreciation doesn’t help much paying the bills and in an economic downturn  has caused many many investors to go bankrupt . Appreciation is nice but it’s speculation .

Bill F. · Answer

@Kimber Lockhart

If you want to maximize total returns over time why not use a calculation that lets you take into account CF, appreciation, amortization, and tax savings in one model instead of jerry rigging the ROI metric to do something it was never intended to do?

Off the bat, ROI/CoC only takes into account cash flow and it ignores time value of money. Both of those facts limit how useful it could ever be for make overall long term investment choices. Never mind attempting to maximize returns in deals with cash flows with varying sizes and timings.

NPV, IRR, DCF, MIRR are much better suited to what you want to do.

Tony Kim · Answer

I don't really have a minimum threshold as each deal in my area is so unique. I have to evaluate its potential on an individual basis. I'm in the process of purchasing a property that will net me around $1,500 per month which equates to 5.6% coc. Most folks here would scoff at that, but it works fine for me.

Kenneth Garrett · Answer

@Kimber Lockhart

I try to stay at around a $300 cashflow for single family homes in my market. A couple of years ago it was $500. The properties I bought a few years ago do great. On apartments I try to stay above $200/unit.  Just a rule of thumb.

Good Luck.

Jay Hinrichs · Answer

pretty standard metrics..  10%  Coc seems to be the bench mark for non or low appreciating assets.

as for areas of historic appreciation.. cash flow with 20% down can be tough..

Cashflow Thresholds - What do you use?

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