the total benefit of owning a property

[Harry Wilson]

I've been analyzing lots of deals lately and the main thing I'm focused on is cash flow, for example I find a deal that is cash on cash of 13% and say to myself that its better than the stock market etc.

however when you add the debt pay down into the equation, the net benefit is increased dramatically, 

here is a calculation I did, no crazy expectations, everything increasing at 2.5% annually.

after a year I cashflow $2,850 however I've also gained 2,124 in equity, totaling 4,974. 

so in reality my actual return is much greater 12.20% cash on cash - 

(2124 equity after a year and as a percentage of the 22250 paid = 9.54%

9.54% + 12.20% = 21.7% 

so really I am making a 20% return on my investment.

why doesn't everyone do this calculation? am I missing something?

[Ryan Taylor]

@Harry Wilson 

Hi Harry, I just came across this thread and it struck a chord with me. I was totally caught up in these numbers as well while I was investigating my first deal. I found that I could make more than 10% cash on cash with monthly cash flow alone, plus another 12% on mortgage pay down. I was stoked! I thought, wow, my 401k comes nowhere near that! 

I took the math a bit farther and did some calculations to see what it would look like to borrow from my 401k to put into more real estate deals. I mean, the math above seems to show you make make 20% or more by combining cash flow return with mortgage pay down. As I started to get deeper into my estimates and as I simulated 10, 20, and 30 years of this growth, the numbers grew to be astronomical.. At that point, I started to realized that something wasn't right. My numbers started to indicate that my equity in the rental property had grown way too quickly and was growing unbounded after my 30 year mortgage had ended.. Something wasn't right. Logically it wasn't making sense anymore.. Then I realized something really important.. 

The 401k grows exponentially and the real estate, when looking at a single property, does not. I was estimating everything based on the same exponential growth formula that you can use for 401k and mutual funds. This was incorrect for real estate estimating. The 10+% for cash flow and 12% for mortgage pay down are really 10% and 12% YEARLY, based on your initial investment. These are not compounded exponentially like a growth fund. So you have to be careful about you estimations here. Once you pay off the mortgage, you'll make more monthly cash flow but the equity growth is then limited by the yearly appreciation rate.. Once I realized this, I found I needed to change my math. At that point, I started looking at how multiple real estate investments, and acquiring more on a periodic basis, could grow my net worth over time. This math still looks good, but not as good as the 22% exponential growth I had incorrectly been calculating. 

Hope that helps

Ryan