HI there! Are you still having meetings? I only see the August one. Also are you aimed at experienced or more beginning investors? Commercial or residential? We have about $40M of AUM in commercial. Looking to meet other experienced investors. Thanks!
Hi! I'm looking for more meetups in Scottsdale! Do you ever do breakfast since you're a "breakfast club"? Also, are you aimed at experienced or new investors? Commercial or residential? We're commercial investors and have about $40M of assets under management. Thanks!
@Kim Hopkins: personally, for my investments:
Direct, single families: I look at my actual cash flow. I have amortizing loans, so I am taking the whole payment, including principle portion of my payment. I divide that by my net equity in the deal, i.e. worth $300k, loan balance is $120k, I have $180k equity. If my net cash flow averages $900/mo, $10,800/yr and I have $180k equity, I am currently yielding 6% return on equity. I can't look at "cash on cash" because I have refi'd all my cash out of the deal.
On my syndication investments: I am looking at annualized distributions divided by investment amount. This is your typical cash on cash equation, and the sponsor is working through their cash flow needs, but to me it only matters what hits my bank account divided by what I funded from my bank account.
On my flips, I look at annualized returns: Buy for $200k, Reno $200k. Sale price $500k. Selling costs $25k. I netted $75k on $400k invested (I do flips all cash). Took 8 months. 28% annualized ROI.
This is my basic analysis of my various holdings. But it also not including everything (primarily appreciation for rentals and syndications), but it is the start and how I look at things from a high level. What are you rentals yielding, what are my syndications yielding, and what are my flip returns.
@Evan Polaski Excellent breakdown.
For your rentals aka "Direct, single families", what do you count as cash flow for a given year if you put on a new roof on for $10k? (So if your cash flow is typically $900/mo, it would now be $65/mo after including this expense).
@Kim Hopkins, I would take a step back and ask yourself: why does it matter? Are these internal analyses? If so, as long as you know what you are calculating in each variation who cares what you call them.
As long as you are comparing your projects in the same way, one to the next, along with future purchases, it doesn't matter at all. It is like Cap Rate. Real simple: NOI/value. Or is the value actually purchase price? Is NOI T12, annualized T3, modified T3, annualized T1, pro forma year 1, pro forma yr 5, etc. If I just say my "going in cap rate is XXX%" all that matters is for my comparisons I am keeping it consistent.
I would argue you are overthinking it, especially if this is for internal purposes only. As you note, debt service affects your actual cash outlay. From a tax perspective, you are really only supposed to count interest expense and not principle pay down. But that doesn't make one analysis right and the other wrong. It means you have different use cases for the same general term.
@Evan Polaski, thanks for your feedback. Well, you are 100% right that I'm certainly overthinking it. LOL. This is what happens when the recovering mathematician is let out of the bag, I suppose.
The thing that got me stuck was that I have this definition of what I think "return" or "cash flow" should mean for ROI and COC which is different from anything else I can find in any of the discussions of ROI or COC on the internet. And if I can't find anyone else who talks about something a certain way, I usually take it as an indication that something is incorrect with my thought process.
Indeed, I would argue that I was thinking about it incorrectly. Instead of leaving all one-time expenses (e.g. roof replacement, lease commissions, TI) out of the "return"/"cash flow" number, I think the right answer now is to include an amortized version (e.g. amortized roof payment, amortized lease commissions, amortized TI etc.).
But that still doesn't match the typical real estate investor's definition of cash flow / return, nor does it match the definition of taxable income (since I'm deducting the entire annual debt service payment with principal and interest, like you mentioned).
It's some definition in between the two.
And so alas, I continue to wonder what everyone else is doing out there...
Hi @Kim Hopkins . By Discount reviews, I usually mean bundle discounts which each carrier can provide despite how many different states your properties are in. Also ensuring the carriers know when any updates are made to your properties.
As far as the agent goes, its hards to find an agent with access to a lot of states. I am only licensed in 5 and it costs a good amount. However, let's say you have everything with the same company via different brokers across the US, you will still get that carriers best discounts! Hope that helps.
We've tried suggesting that. She said she can't bundle due to some building issues, so she's not getting the benefit of the entire portfolio.
I'm bundling the ones I can, just to clarify. One subset of Portland warehouses cannot be bundles with the rest because the standard carriers all declined them, but these Portland warehouses are bundled together with a non-standard carrier.
Long post alert! (Worth the read though) I hope that you
Oh snap, @Cameron Moore I almost didn't see your post! Thank you so much for this explanation. This is extremely helpful and insightful.
Two follow up questions -
First, when you talk about "Discount Reviews",
Do I just ask my agent if they have any discounts?
Second - we are working with an agent that is in a city where we have a lot of properties, but we have most of our properties in other cities/states and we do not live in the same state as the agent. I appreciate what you said about long term relationships and not "plan shopping" for sure. Do you think, however, that it would somehow benefit us in the long run to make a one-time switch to an agent that is local to where we live? Note we do not actually own any properties where we live.
Thanks!
Return on Equity (ROE) in real estate gauges the profit from a property investment in relation to the equity you have in it. Simply put, it's calculated by taking the profit (or cash flow) and dividing it by the Total Deployable Equity—remember to account for selling commissions if the property is sold.
A lot of people don't often consider ROE.
To put it succinctly: ROE helps investors decide which assets to sell, refinance, or draw a HELOC on. The goal is to weed out stagnant or "lazy" equity.
Pro Tip: While the principle of "buy and never sell" has its merits, adopting a "buy, then regularly review your ROE" approach can lead to superior returns and better preservation of capital.
Among many metrics used by investors to evaluate the quality of their assets, a few stand out:
Cash on Cash (COC)
Return on Investment (ROI)
Return on Equity (ROE)
Wise investors will often recalibrate their strategies if their ROE begins to decline. I personally think 10-15% is a good range to put something on the selling table.
Cash on Cash Return (COC):
COC determines the pre-tax cash flow at the year's end divided by the initial investment amount. It's a useful tool to contrast your property venture with other investments, especially since it disregards factors like mortgage leverage, taxation, appreciation, and mortgage reduction over time. As your investment matures—with tenants paying rent and the property appreciating—COC becomes less of a focal point AFTER the purchase.
Example: If you invested $30,000 into a property (comprising a $22,500 down payment, $5,000 in closing fees, and $2,500 for renovations) and you earned a net profit of $10,000 after all expenses in the first year, your COC return is 33%.
Savvy investors use COC alongside other metrics, such as ROE, to gain comprehensive insights. Typically, non-real estate ventures like mutual funds and stocks hover around 8-10% in COC returns.
Annualized Return – Measuring Performance Over Time: Annualized return offers a longitudinal view of an investment's performance. In real estate, it's not about quick wins. Some investments, especially those needing rehabilitation, can take years to fully realize. This metric combines cash flow during the property's tenure and the profit from its sale or refinance.
Example: On a $100,000 investment with an 8% COC return over 5 years (equating to $40,000), coupled with a $60,000 profit at the end of the term due to property appreciation, the annualized return is 20% per annum.
One bad thing about of real estate is its illiquidity, barring selling or refinancing the property. As you retain investments, your equity position increases via: Paying down the mortgage, Market-driven appreciation, Value addition through property improvements.
Let's illustrate this with a scenario: An initial investment on a $100,000 property generates a 20% COC return annually. A few years later, the same property, now valued at $160,000, fetches a profit of $5,000 per annum. This brings the ROE down to a mere 6.25%. Considering the challenges of property management, such an ROE may not seem appealing. Many experts believe that when ROE slips below 10-15%, it's time for a strategic overhaul—either through refinancing, property exchange, or outright sale.
Hi Lane,
Thanks, but that wasn't my question. I was asking about the definition of "Return" (i.e. the numerator) in ROE.
My point was that it's usually defined as cash flow which is defined as:
Cash Flow: = NOI - One Time Expenses - Debt Service.
Here, One Time Expenses includes things like:
* Leasing commissions
* Capital improvements
* Tenant unit improvements
My point was that if you deduct something like a new roof from your cash flow in a given year, then the ROE for that property will plummet for that year and not give you a clear picture of the performance of this property.
Similarly, if you sign a new 5-year lease, you will have to pay a large leasing commission, which would also drive down ROE in the given year and be misleading.
Maybe in the examples above, you do want to amortize these expenses in your definition of cash flow, i.e. redefine cash flow as:
Cash Flow := NOI - Amortized One-Time Expenses - Debt Service.
But you don't want to include something like depreciation for example, because if you do a cost seg study, it could give you a negative ROE for example, which is also misleading since the property was likely cash flow positive.
THAT was my question.
Leverage is always going to almost always show you a better look, but if you think investing is strictly numerate you're going to learn the hard way. It's every bit behavioral too, you really sit in the leverage area for as much as you can tolerate. And most really, really sophisticated investors don't go out there and leverage things even like real estate. Tolerance levels the past dozen years + was great with debt service never creeping up, but go check the bal-decade interest payments vs the last 6-7 years. It's just going to be an incredibly difficult time to think being cute with debt is as fun.
Hi @V.G Jason,
No, leverage is NOT going to almost always show you a better return. That's the entire point of what I've shown above, and you echo the same point at the end of your comment where you say: "It's just going to be an incredibly difficult time to think being cute with debt is as fun."
The reason this is true is what I've said above.
There's a specific interest rate, I, so that the mortgage constant, M(I) is equal to the cap rate.
If the interest rate you can get for your property, i, is LESS than I, then it is TRUE that cash on cash INCREASES as a function of loan amount. So what you said is true in this case.
However, if the interest rate you can get for your property, i, is GREATER than I, then cash on cash DECREASES as a function of loan amount. So the more debt you take on, the worse your property performs. This is what makes your last point true - that you cannot be "cute" with debt right now. To say it another way, the interest rates right now make it IMPOSSIBLE to increase the return of your property using leverage.
Furthermore the mortgage constant, M(i) is always greater than the interest rate i itself, and M is an increasing function of i, so the interest rates have to be MUCH less than the cap rate (i << M(i) < M(I) = cap rate) in order to get a cash on cash return that beats no-leverage.
So we need to come a LONG way down in interest rates for leverage to be cute again.
@Immanuel Sibero Thanks for showing that data!!
@Kim Hopkins This sort of thing was going through my mind when I first responded. usally when you run a series of calcs the CoC isn't constant...
You trying to analyze this stuff in your head? Just wondering why you need these sort of relationships. I would think that normally a spreadsheet or other computer system would calculate anything you'd want with these basic inputs.
Hi @David M.
I'm trying to be able to analyze properties in my portfolio for a keep or trade analysis.
some of the properties are debt-free, and so I need to also look at whether adding debt to the property improves the return. (And even for properties with debt, the same analysis is helpful to know if refinancing improves returns.)
I want to be able to analyze this keep or trade decision as simply as possible, having to analyze as few possibilities as possible.
So for example, based on what I wrote above, I can solve for "I" above with a very simple spreadsheet calc, using my property's current cap rate.
Then I can take the current market interest rate for a typical loan for my asset class, and compare it to I.
This will tell me immediately if adding debt to this property could possibly improve the returns over the current return.
as another cute little application, it turns out that if the cap rate of my current property is less than 1/Y where Y is the years of amortization for a loan, then any interest rate and any loan amount will give a cash on cash less than the cap rate of the property without debt. So for example if you take Y to be 25 years which is the typical amortization for my asset class, then 1/Y is 4%. I have some older properties with undermarket rent where the cap rate is less than 4%. I now know immediately that adding debt to these properties will not improve their return no matter what the loan amount is OR the interest rate! No calculations at all needed!
@Immanuel Sibero Awesome! Yes, there are several ways to prove it, but yours I think is the cleanest, great!
Now back to explaining this "in words", I love the direction you were going with that, but when you conclude:
"
In this scenario, IF the debt holder demands 10% INTEREST can you see that you, as the owner, would also get 10% COC? The reason for this is because the property happens to be paying 10% CAP Rate, so everybody gets 10%!"
I believe you (of course, since we already proved it's true), but I don't see why if the cap rate is 10% and the debt holder demands 10% in interest, then we get 10% in COC. Does that make sense to you?
I'm having trouble answering... lol, how about alternative answers below:
- Based on the formula I laid out, when cap rate is 10% and interest rate is 10% then by definition COC is 10%.
- As owner, your portion of the property's rate of return is residual (whatever is left). Lender's portion of the property's rate of return is contractual (first dib). If the lender's contractual rate of return is higher than the property's rate of return, then the owner's rate of return would be lower than the property's rate of return... and vice versa. By the same logic, if the lender's contractual rate of return is the same as the the property's rate of return, then the owner's rate of return would necessarily have to be the same as the property's rate of return.
- If cap rate is 10% and debt holder demands 10% then COC can NOT be higher than 10% because this would require cap rate to be higher than 10%. In the same way, COC can NOT be lower than 10% because this would require cap rate to be lower than 10%. So COC has no choice but be 10%!
Which of the above do you like? :-)
Cheers... Immanuel
Hi @Immanuel Sibero! I've been working on applications of this concept all week. I have some good stuff to share but I need to iron out the kinks first.
In terms of your option of explanations "in words"... I'm going to add one to the mix...
It's really just a general rule about ratios and proportionality:
If A/B = C/D then (A-C)/(B-D) = A/B = C/D.
In words:
if A is proportional to B, and C is equally proportional to D then the difference of A and B is equally proportional to the difference of C and D.
So it's really just about understanding WHY this general statement is true.
I tried to discuss it with ChatGPT, but I swear that guy is not as smart as everyone says he is...I still don't intuitively see it.
But nonetheless, the application is if the cap rate (NOI/PP) is equal to the mortgage constant (DS/LA), then the differences are equally proportional, and that's the cash on cash (NOI-DS)/(PP-LA) by definition.
By the way, the same is true for a regular loan, not just interest only!
Now I'm trying to get a list of relationships like this between the cap rate and interest rate that effect the cash on cash, so that I can easily analyze any property using these simple inputs .... stay tuned ...
But nonetheless, the application is if the cap rate (NOI/PP) is equal to the mortgage constant (DS/LA), then the differences are equally proportional, and that's the cash on cash (NOI-DS)/(PP-LA) by definition.
I was not a math major, maybe that's why I'm having trouble answering your question. But I feel like I'm going in circle. As normally defined, COC = CF/DP where CF is Cashflow and DP is down payment. I can restate your statement above with substitutions in bold font... and it would also be true:
But nonetheless, the application is if the cap rate (NOI/PP) is equal to the COC (CF/DP), then the differences are equally proportional, and that's the Interest (NOI-CF)/(PP-DP) by definition.
Are you NOT interested in the “why” for this proportional equality?
By the way, the same is true for a regular loan, not just interest only!
Interest Only has been a necessary assumption in all my responses, so I don't agree with this statement. If you were to amortize the loan by 1 dollar, COC would go out of synch (i.e. no longer equal to interest rate or cap rate). But since you made the claim, you have the burden of proof... lol. So how would you show that with an amortizing loan, when i = C, then COC also = C?? I just don't see it possible.
Last comment for today... here's another quote from your earlier post:
I've written it all out with actual math proofs for myself. I can't believe this doesn't exist anywhere. Can't find it anywhere online. It's incredibly helpful for analyzing an existing portfolio or a new acquisition since you can very quickly understand what adding debt to a property will or will not do to it's COC.
So, property analysis seems to be your bottom line (i.e. not necessarily the math connections between debt and COC). Well I made a post quite sometime ago that covers exactly this, that is, the impact of debt terms on COC... So YES, it does exist and it's been written before :-) Here is the excerpt:
I was evaluating a property with the following metrics:
Cap Rate: 6%
Interest Rate: 4%
LTV: 75%
Since the spread between cap rate and interest rate was slim (2%), I knew COC would be low. Since low COC means running the risk of negative cash flow which means risk of not paying the loan, I wanted to know how the various loan terms affect COC. For example, how sensitive was COC to the Cap and Int spread. This can easily be done using sensitivity tables in Excel. Based on the financial data of the property, following are two sensitivity tables:
As you can see, my Cap rate - Int rate spread is 2% and from the first table it puts my COC at 2.39% which is concerning. Note that this table shows how sensitive COC is against the spread.
Second table shows how sensitive COC is against LTV. It shows that 75% debt is about the most I should borrow. Anything higher can put me in negative cashflow. HTH
Cheers... Immanuel
I'm writing this from my phone so I can definitely clarify more later from the computer if needed, but this is getting exciting so I wanted to respond now!
First, I am very interested into WHY the proportionality holds in the interest only example. That's why I keep asking you to say it 10 different ways, but none of them have exactly clicked yet for me :-)
Now moving on to the example of a normal loan that is not interest only.
In this case, there is something called the mortgage constant M, AKA mortgage capitalization rate, which is defined as the debt service divided by the loan amount, DS/LA. By definition M*LA = DS. If you look at the formula for this,
M = i/(1-(1+i/12)^(-12Y) where i is the interest rate, and Y is the amortization years. You can see clearly that this number is independent of the amount of the loan LA, or the LTV.
Fix an amortization rate Y. And write the notation for M as M(i) to indicate that it is a function of the interest rate i.
Then here is the analog for a regular loan of what we have been discussing for an interest only loan:
Suppose you have a property with cap rate C.
Then there is one unique interest rate, I, so that the mortgage capitalization rate M(I) equals the cap rate C.
M(I) = C.
Then for any interest rates i with i< I, your cash on cash will increase as a function of loan amount. In other words the more loan you take out, the better your cash on cash.
Conversely, for any interest rate i bigger than I, your cash on cash will decrease as a function of the loan amount. So in particular, your cap rate for that property is going to be bigger than any cash on cash return with any amount of debt. In other words, the property will perform better without debt than with debt, regardless of the loan amount.
So in the example you did with the sensitivity analysis, you could just calculate I, and then you know instantly that any interest rates less than I will give you cash on cash better than your cap rate, and any interest rates greater than I will give you cash on cash less than your cap rate and will decrease with the more loan you take out.