cash on cash return (Should I cash out with a mortgage?)

[Will Murphey]

Hi all.
Please review my analysis of increasing my return on my ‘paid off’ rental property.

Today I read a book that described cash on cash return vs ROI. and I'm thinking about obtaining a mortgage to get a better return and using the cashed out proceeds to look for another deal.

Details:

Purchased price 15 months ago with updates (new roof/paint job) was $22,400 (purchased with cash)
Cheapest 2 bed/1 bath today is $39,900 in my town on MLS.

Rental income last year: $600 per month on HUD
Property manager last year: 8% monthly
Last year expenses: $120 (wife and I replaced the tub handles/hardware) I will forecast $500 for the upcoming year.

Taxes paid last year: $383
Insurance paid last year: $480
Vacancy last year: None (Although I'll forecast 2 months vacancy for the NOI calculation below (2 months vacancy hopefully is the worst case scenario)

HOA: None

If my numbers are right my NOI in 2013 might be: $4147

Income: $600 rent* 10 months = $6000 annual rent
Property mgt: $6000 *.92% property mgt (8%) = $5520
Taxes: $5520 - $383 = $5137
Insurance: $5137 - $480 = $4657
Projected expenses: $4657 -$500 = $4147

If my calculations are right, my ROI this next year might be 18.51% if nothing changes.

Please review my thought process below regarding obtaining a mortgage. (Thanks in advance!!)

Obtain a loan from the bank at 4% interest rate for 30 years, put 20% down of $22,400 (my purchase price) Although maybe the bank will give me a loan for more, not sure how this works or how it would affect my cash on cash return.

After running a few mortgage calculators, my debt service on the assumptions above will be $107 monthly.

So my cash on cash return for 2013 might be: 63.9%

$4480 (20% cash outlay) / $2863 ($4147 NOI – Annual debt service $1284 (12 months * $107)) = 63.9%

I few things I don’t understand or where they fit into the calculation are:
If the bank/appraiser says the house is worth what I paid for it $22,400, do they simply cut me a check for $17,920 ($22,400 house value – my 20% down payment)?
Closing costs— Can this be financed in? If so, how does it affect my cash on cash return?
If the house is worth $35,000 by appraisal, can I / should I get a loan for that amount? How would that affect my cash on cash return.

Thanks for looking at this!!!!
Will

[Sebastien B.]

I'm a proponent of having as little equity in my investments as possible. The only time I see a need to have more equity in an investment is when its the only way to increase cashflows.

I.E if cap rates are 10% and interest rates are 11%, I make 1% more for decreasing debt instead of decreasing equity.

Right now, for every dollar you take out of equity and use for another levered investment, the better off you are.