Do you factor loan pay down in your cash on cash returns?

Question

I was calculating my cash on cash returns on a property I bought a few months ago. My cash flow is about a $1000 a month, and for the past 6 months $600 of my mortgage payment went toward the principal. Is my cash on cash return $1000 a month or $1600 a month? Thank you for your help!

Adam Adams · Answer

@Peter Milic,If 1000 is your "cash" flow/month and at the same time your mortgage is having a principal paydown netting another 600/mo...Answer: Your Cash on Cash return is $1000The "Principal Paydown" isn't calculated in your Cash, but it is amazing!!! Call it a "bonus".Notes: 1) The rents going to your mortgage, principal as well as interest, do count toward your "Cap Rate".2) you also are getting Tax "Depreciation" as well as Property "Appreciation" which are two other "bonuses" that don't get calculated into your "Cash on Cash Return" ...I am thinking about taking some of those "Quotes" out... nah

Joe Villeneuve · Answer

Taking a step further...or backwards, the term CoCR should never be used on commercial property. Use the term "CAP RATE" instead...and never use the term CAP RATE on a residential property.

Andrew B. · Answer

You can include it in separate analysis, but it is not included in CoCR because it is not a cash inflow it is still an outflow. it is also imaginary wealth, since equity can disappear in an instant if the market takes a downturn. as a side note, I hope you are including all expenses when you say you have a return of $1000 a month....your profit is most definitely not simply the difference between rent and mortgage payment.

Joe Villeneuve · Answer

I can't argue with you on your statement, however if you look closely at mine you'll see why I way they are basically the same thing. It's based on those differences, specifically their uses....residential vs. commercial. In the end, they are both measures of the same thing...getting your seed money back to be able to move forward again...all within the first year. However, one is a commercial measure and the other residential.The basic difference between the two is based on how the two types of RE are purchased. Commercial is rarely all cash...and residential more often than not can be.I do love the fact that you use CoCR for both commercial and residential...so do I. I use the same system for both. I only use CAP Rate for commercial though, as I originally stated...CAP Rate is a Commercial analysis term/method.

Adam Adams · Answer

Peter, the principal paydown is part of what they call IRR (internal rate of return). this is the number that includes everything you are making. Hope this helps!-Adam Adams

Dave Toelkes · Answer

@Peter Milic,Your cashflow is $12000 per year ($1000 per month). Your cash on cash return is a ratio (percentage) calculated asCOCR = (Annual Cashflow) / (initial cash outlay) x 100%For most of us with residential rental proprety, the initial cash outlay is the amount of money we had to bring to the settlement table to complete the purchase. For some it also includes the amount of out of pocket money used to rehab/make ready.Example. if your downpayment and closing costs that you paid in cash totalled $48000 then your $12000 annual cashflow divided by $48K gives you a cash on cash return of 25%. If you paid $240K cash for the property and own it free and clear, then your $12K annual cash flow after all expenses are paid gives you a 5% COCR which is equal to your return on investment and is also equal to your CapRate. In this instance, $12K is also your Net Operating Income.

Adam Adams · Answer

Joe, respectfully, CoCR and Cap Rate are definitely not "basically the same thing". 1) Cap rate measures the rate at which you capitalize your investment back based on the purchase price and the net operating income (not including debt service). Gross income and Gross expenses (besides debt service) based on purchase price.2) Cash on Cash Return measures Cash invested in acquisition vs Net cash back in your pocket after ALL expenses (including debt service) and has NOTHING to do with the purchase price.Please Note: The ONLY reason I am correcting you is because there are a lot of new people reading these and the last thing I want is for a new person to think CoCR and CAP are "basically the same thing". I believe every investor should be looking at CAP & CoCR & IRR & DCR when underwriting a potential investment opportunity, furthermore I believe every investor should know the difference between them.

Peter Milic · Answer

Adam Adams great answer Adam, thank you so much! This is my first 5+ property so I'm trying to figure out if I made a good deal or not. I new some stuff when I was buying it but not everything. So far looks like my cap rate will be around 7.5 and I'm happy with that, but my COCR is only around 8%. I've put 25% down and had to invest more money to fix it. they said on the podcast once not to pay what property will be worth in the future, I think I that that's what I did, but I'm happy, it's a perfect location for me and I self manage for some extra money, and the loan is getting payed off, all in all not to bad I think. Thanks again!

Joe Villeneuve · Answer

Correct, but the question was about Cash on Cash Returns. CoCR only involves cash...for the first year only. So the more he comes out of pocket to with his own cash to pay down the principle, he is lowering his CoCR since that new flow of cash is going to wrong way.On a side note, the only thing you are accomplishing by using your own cash to pay down a loan, is reducing your CoCR, and reducing the amount of interest you end up paying on the loan...at the end of the loan term. All you are doing is exchanging your cash, and its ability to grow through investments, for equity, and its possibility of going down as much as it is going up,Keep the cash in hand, and use it forward, not backwards. Let the tenants pay off your mortgage (they do such a nice job of it for you).

Joe Villeneuve · Answer

It's 400 a month. That extra payment is cash going the wong way. Equity isn't involved in CoCR...it isn't cash. You're going backwards.