Expected Returns

[Manesh Hardeo]

What in your opinion makes for good cash on cash returns? Now I know this can vary depending on the risk of the area, but generally speaking what do you expect?

I see companies advertising 25% cash on cash returns, but when I calculate the numbers I'm not seeing taxes, insurance, management (i know this is optional), 2 months vacancy, and even tenant placement being factored. After all those costs what would you expect?

I'm curious to see the response. Thanks for your help!

Manesh

[David Beard]

Manesh -- there is no one-size-fits-all answer. You're right, it is dependent upon the economics and housing conditions of each local market, the grade of the property and neighborhood, the risk tolerance and stage of life of the investor, the time the investor has to devote, a million things.

In the areas here, I'm targeting 3%/mth gross rent return on 2/1 SFRs, 2.75% on 3/1's, and 2.50% on 3/2's. For small multi's (2-4’s), I wouldn't even consider anything less than 3%, depending on the age/condition of the building, and who pays the utilities. But I'm pretty cash flow-focused, I'll admit, as I'm planning to fire myself from my current job in the next year. Others just want a no-hassle investment as a retirement asset.

I closed on a 3-unit yesterday. This is in a C area (by no means a war zone, police officer owns the building next door), but sits across from a new elementary school and the current tenants are long-term and have kids going to school across the street and at another school nearby. So they love the location and seem very planted. I paid $18.6k, the seller paid $106k in 2007, I kid you not. The two tenants pay $1259/mth (2BR and 3BR units), and a basement 1BR apartment that is vacant and needs cosmetic rehabbing. Gross rents will be $1,600/mth after rehab, in a month or so. I need to put $10k in the property (windows/roof) to stabilize it for the long term. These return numbers were shocking to me when I first got into this a year ago. But I do run the vac/exp ratio at a floor of 65% when I evaluate these types of multi’s. I have a prop mgr that will handle everything, someone who has hundreds of units and top-notch systems in place to deal with things. I wouldn’t even THINK about managing a property like this personally.

The houses we’re buying need to be in stable areas, with reasonable owner-occupant ratios, moderate crime statistics, at least SOME retail sales occurring in the neighborhood, not in the boonies, etc. To me, these are properties that truly can be managed at 50% vac/exp ratios. Other investors buy the large old 10k, pure Section 8 houses with lots of BRs, they obviously require a ton of time to manage effectively. Contractor-types love to grab these properties, they can fix them up at cost and get 5%/mth on rent, as they have the band-width and resources to manage them to high profitability. Other folks want the better properties with rent returns of 1.5%/mth, with better tenants, higher rents, less headaches, easier to bank finance, where vac/exp ratios could probably be run at 45%. So there’s a vast community of investors out there with vastly different appetites for risk, return, and time commitment. It’s nothing like investing in financial assets, that’s for sure, more the proverbial wild west. You need to become a serious student of investing, and study your market like your life depended on it, or you can become a bankruptcy court statistic.