Cash Flow Returns.

[GaryMcGowan]

Looks like this thread has taken on a life of its own!

For our RTO properties we have chosen a fixed rate mortgage. This is so we can eliminate the "what ifs" for the vrm. Keeping in mind we only plan on holding the property for 2-3 years. We can forecast our monthly cash flow really well this way.
On another note we sold one of our RTO properties today to our tenant/buyer and we are within $500 of what our forecast was to our partner at the beginning of the investment.

 

[Thomas Beyer]

QUOTE (Rickson9 @ Jul 30 2010, 10:53 AM) Suddenly I feel oddly inadaquate and very stupid.
I met a rich man once. I asked him how he made all his money. He said: Well, I import widgets. They cost me about a dollar each. I import millions of them. I sell them for $2 each. And I keep the 1% difference !

 

[Thomas Beyer]

QUOTE (bizaro86 @ Jul 30 2010, 11:35 AM)
..



Godfried's chart (and Neil's equation) show that as leverage increases, so does your cash on cash return, but it also increases your downside risk. ..


Actually what neither the chart and nor the formula show is PRINCIPAL payment. While the mortgage principal payment is "return" it is not cash. Cash is cash. Equity (trapped in an asset through mortgage paydown) is NOT yet cash .. it is future cash !



Many people are equity rich and cash poor !



Thus: please differentiate between CASH and EQUITY .. as most grocery stores do not take equity !



I have asked many a cashier clerk "Do you take Equity?" when they ask me "How do you wish to pay?" !!

 

[bizaro86]

To calculate cash on cash return you should substitute the mortgage ratio for the interest rate. ie, if the annual payments are 6% on a 4% interest mortgage, use 0.06 instead of 0.04. This will give you cash on cash, instead of including the principal paydown benefit.



Michael




QUOTE (ThomasBeyer @ Jul 30 2010, 12:47 PM)
Actually what neither the chart and nor the formula show is PRINCIPAL payment. While the mortgage principal payment is "return" it is not cash. Cash is cash. Equity (trapped in an asset through mortgage paydown) is NOT yet cash .. it is future cash !



Many people are equity rich and cash poor !



Thus: please differentiate between CASH and EQUITY .. as most grocery stores do not take equity !



I have asked many a cashier clerk "Do you take Equity?" when they ask me "How do you wish to pay?" !!

 

[Thomas Beyer]

QUOTE (bizaro86 @ Jul 30 2010, 02:00 PM) To calculate cash on cash return you should substitute the mortgage ratio for the interest rate. ie, if the annual payments are 6% on a 4% interest mortgage, use 0.06 instead of 0.04. This will give you cash on cash, instead of including the principal paydown benefit.

Michael
indeed .. and what you will see that the cash-on-cash return IS QUITE A BIT LOWER .. or negative if too levered !!!

Thus, on a single family asset, where the CAP rate rarely exceeds the interest rate, negative cash-flow is virtually guaranteed with 75%+ leverage when using 10% vacancy or slight unexpected R&M expenses for new carpet, new dishwasher, paint, ...

cash-on-cash is ONE metric .. a 2nd on is equity-on-cash .. and a 3rd is total ROI over a longer period, say 5 years .. as a single family home with 0 appreciation in 5 years usually does not make sense as an investment .. counting risk, money and time invested !

 

[Nir]

QUOTE (ThomasBeyer @ Jul 30 2010, 12:47 PM) Many people are equity rich and cash poor ! most of them probably don`t have good CAPs then.

Thus: please differentiate between CASH and EQUITY .. as most grocery stores do not take equity !
Understanding the difference is important and that`s a good reminder. However, I believe the formula I provided taking BOTH principal reduction and net income is even more important in order to make a buying decision. The reason is your real average net income is more accurately reflected in the formula I developed because it also takes re-financing and selling into consideration which most if not all plan to do.
In other words, with time your income will be approaching the ROI (in %) as shown in the formula thanks to refinancing or selling.

 

[Berubeland]

Cash on cash return is the return you get on any cash investment you make into the property. Usually the downpayment.

Equity and appreciation are not counted when calculating Cash on Cash returns because it is not a readily accessible source of funds (cash)

For example if you paid $1 million for your building and you put down $300,000. The money left after you pay for all expenses and allowances for property management, vacancy and maintenance to be either put aside or used if required that month is your Cash on Cash Return.

If your cap rate is 5% and your mortgage is 5% you make 0% Cash on Cash
If your cap rate is 6% and your mortgage is 5% you make 1% return on 1 million (asset value) or roughly 3.3% Cash on cash

Roughly speaking assuming an honest cap rate a beast rarely seen in today`s RE Market

In any case I have a cap rate spreadsheet if someone wants it. It`s been nicely engineered to do a reverse cap rate to determine what you want to offer on the property according to the rate of return you want.

 

[Thomas Beyer]

QUOTE (Berubeland @ Aug 4 2010, 02:08 PM) ..

If your cap rate is 5% and your mortgage is 5% you make 0% Cash on Cash
If your cap rate is 6% and your mortgage is 5% you make 1% return on 1 million (asset value) or roughly 3.3% Cash on cash
Actually what you show is usually referred to a Return on EQUITY (ROE) .. not cash on cash as you pay down the mortgage .. about 10% in 5 years using a 25 year amortization.

ROE is a very important metric and REAL RETURN .. but not cash. In fact, in many buildings I held (or still hold) the cash is always super tight if you`re levered 70% + .. but the return is fantastic as you pay the mortgage down and the building in 5 years on mortgage re-fi date is usually worth a lot more due to higher rents and ongoing repairs !

[That`s why we pay little if any cash distributions .. and have low to no salaries but equity stakes .. as the cash flow is just not there .. just the overall often fantastic 5 year ROI]

If your CAP rate is 5% and your mortgage is 5%, using a 25 year amortization, and the following loan-to-value your cash-on-cash ROI is negative until you put down 30% !

LTV Cash-on-Cash ROI
90% -13.86%
85% -6.87%
80% -3.38%
75% -1.29%
70% 0.11%
65% 1.11%
60% 1.86%
50% 2.90%


if you assume a 6% CAP rate and a 4.0% interest rate .. a more realistic assumption in summer 2010 ... you arrive at the following cash-on-cash return:

LTV Cash-on-Cash
90% 2.39%
85% 3.73%
80% 4.40%
75% 4.80%
70% 5.06%
65% 5.25%
60% 5.40%
50% 5.60%

NOT SO BAD !!! add 3% annual appreciation and it is fantastic .. but please allow for significant R&M expenditures usually not shown in ROI calculations !

LTV ROE + Appreciation at 3%
90% 49.50%
85% 34.50%
80% 27.00%
75% 22.50%
70% 19.50%
65% 17.36%
60% 15.75%
50% 13.50%

Use 5% appreciation and arrive at:

LTV ROE + Appreciation at 5%
90% 69.50%
85% 47.83%
80% 37.00%
75% 30.50%
70% 26.17%
65% 23.07%
60% 20.75%
50% 17.50%

In the real world, you have to include realistic expenses and R&M upgrade costs that will reduce the actual return on cash invested .. but still very decent in an appreciating market like AB, SK and select pockets of NB, MB, ON, BC or TX !

 

[Berubeland]

Thomas I said exactly what I meant. It is not ROE it is cash on cash. The return does not account for mortgage paydown. It is how much money the investor gets back every month after paying all the bills.

For a million $ property I am assuming 30% down commercial that is the norm.

Honest cap rates always already include an allowance for Vacancy, Maintenance and Property management. In Toronto that`s 22% of the Gross Income. Not sure why you`d need more than that unless there is Deferred Maintenance which should actually be included as part of your budget when you buy the place. Any investor I know rolls that into their expectation for cash on cash return.

 

[Thomas Beyer]

QUOTE (Berubeland @ Aug 4 2010, 07:57 PM)
For a million $ property I am assuming 30% down commercial that is the norm.


For commercial, 25-35% is usual if the CAP rate is high enough, in good condition and stabilized. More down if smaller center or ugly or any vacancies.




QUOTE (Berubeland @ Aug 4 2010, 07:57 PM)
.. In Toronto that's 22% of the Gross Income. ..


Commercial is different than single or multi-family as the tenant pays: taxes, upgrades and utilities.



Thus, in multi-family the expenses are often in the 33% to 40% range.

 

[housingrental]

I second Thomas`s above post

 

[gwasser]

QUOTE (ThomasBeyer @ Jul 30 2010, 03:27 PM) indeed .. and what you will see that the cash-on-cash return IS QUITE A BIT LOWER .. or negative if too levered !!!

Thus, on a single family asset, where the CAP rate rarely exceeds the interest rate, negative cash-flow is virtually guaranteed with 75%+ leverage when using 10% vacancy or slight unexpected R&M expenses for new carpet, new dishwasher, paint, ...

I wanted to get back to the point above made by Thomas and also his increased interest for multi-family properties in Edmonton and Calgary.

First: Yes it seems that multi-family properties are becoming more attractive. But are we truly in a market where 4 and 6 plexes become economic?

Second and for many smaller guys such as myself maybe more relevant: Thomas states for single family properties (and I include for this discussion town houses and apartment units - bought one at a time) the cap rate seldom exceeds the interest rate.

In Calgary we can buy single units for cap rates between 3 and 4% while interest rates are 4% or less (variable rates are just around 2%)? Would that mean that we have here now an attractive investor`s market?

I would like to add a metric of my own as well. A typical non-leveraged ROI on investment (for both stock market and real estate) lies around 11-12% per year long term. With Calgary`s appreciation rate of the last 40 years lying around 7-8% (although Thomas pointed out in another post that over the last 50 yrs appreciation was closer to 6%), that would mean that in an investment grade market, the cap rate should be around 3-4%. (If you add leverage the ROI would of course go up quite a bit).

So is Calgary now a good place to invest both on a multi-family and single property basis?

BTW did you read in the Herald today that Alberta`s employment picture is improving and that last month we actually outperformed the nation?

Since this topic has driven so far from the original question, I will post this under a new topic. Please make your response there. The topic here is what people consider an attractive Cash-on-Cash return as asked by Gary McGowan.

 

[Thomas Beyer]

QUOTE (gwasser @ Aug 7 2010, 12:07 PM)
..

.. A typical non-leveraged ROI on investment (for both stock market and real estate) lies around 11-12% per year long term. ..


more like 6-8% .. TSX is up roughly 40% over 10 years ..



and to hold real estate for 10+ years you MUST count some capital upgrades like: new hot water tank, new carpet, new roof every 25 years, new outside paint, new bathrooms ... so it is too easy to add a 3% CAP rate plus a 6% appreciation and say it is now 9% !!



YOU WILL RARELY FIND A consistent low-risk 12% unlevered ROI .. ANYWHERE !!!



And yes, you can make a ton of money in Calgary with appropriate leverage !!

 

[housingrental]

Re Godfried`s above post
the cap rate should be around 3-4%. (If you add leverage the ROI would of course go up quite a bit).

So is Calgary now a good place to invest both on a multi-family and single property basis?

The answer is no.

Too much risk for the potential return. No money to be made from operations and risk of burning through cash on an ongoing basis when things don`t go perfect - vacancy, damages, market rents lower, condo fees increase - and also likely scenario of:
Returns available from alternate investments increase
Cost of operations (interest rates, tax`s, etc.) move up and significantly outpace rent increases

We`re entering a lower inflationary environment. The next ten years the appreciation rate is unlikely to revisit what has been.

 

[Thomas Beyer]

QUOTE (housingrental @ Aug 8 2010, 09:31 AM) ..
So is Calgary now a good place to invest both on a multi-family and single property basis? [/i]

The answer is no.

Too much risk for the potential return. ..
Where is the risk LOWER ?

Low inflation ?

What about:
a) Alberta has lowest unemployment still across the country
b) gas prices rising --> more jobs
c) higher oil prices --> more jobs
d) Wild Rose in (coalition) government in 2012 --> lower taxes and even more jobs
e) baby boom right now in AB
f) low debt and low deficit
g) growing oilsands extraction, both conventional oilsands (pit mining) as well as SAGD (Steam Assisted Gravity Drainage, i.e. underground)
h) thus, growing provincial revenues
i) higher price for a barrel of the tar-like oilsands, which used to sell at a 30% discount to conventional WTI (West Texas Intermediate) oil .. which is estimated to eventually surpass the thinner benchmark oil barrel WTI .. which all means:
) more government revenues, less deficits, less or no debt, more jobs, more n-migration, thus higher home prices and rent !

Where is a better place to invest ?

The ONLY difference (to the past 10 years) is
1) that overall return expectations need to be lowered and
2) that less leverage has to be used to obtain cash-flow !!

 

[housingrental]

Hi Thomas
Re your above post
Cash and bonds
Wait for opportunity to present itself before taking action.
Your situation, with a regular stream of continual material funds might lead to a different course of action but is atypical from most investors.

As for your points listed:
Current performance not indicator of future
Job growth and population increase is tied to oil prices - these are a few of the factors to consider over a long term purchase - no idea where next few years will go -
a) The underlying valuation of asset being propped up from speculation, excess liquidity, and future expectations (which might not play out), and geopolitical concerns ( which might improve)
b) Technological improvements allowing for cheaper cost of production
c) Technological improvements reducing demand and long term demand expectations

Make no mistake 30 years from now you will see electric not gas powered cars flooding the streets of China.

 

[Thomas Beyer]

QUOTE (housingrental @ Aug 9 2010, 09:14 AM) ..
Make no mistake 30 years from now you will see electric not gas powered cars flooding the streets of China.
indeed .. because oil will be so expensive by then and has so many other uses than transportation or heat !

This world cannot function without oil !

Oil is used for
a) food production / fertilizer
b) plastics (your keyboard / PC for example)

Most products in our modern world use OIL based products i.e. petrochemicals. Thus, the tar-like oilsands will be more expensive per barrel as they have longer chains of hydrocarbons (70+ CH molecules .. as opposed to 20+ with more conventional oil) .. huge benefit for petrochemical industry !

I think we will first see more natural gas powered vehicles as this makes a ton more sense than gasoline if oil is $150/barrel or higher. And then, you are right, electric vehicles, in 20-30 years, but this assumes oil at $300 or more .. and very high natural gas prices.

Electricity is NOT a great transportation alternative due to weight. Batteries are heavy and store only 1-2% of the same energy per kg of weight compared to gasoline !! 50 times less !! Thus, electric vehicles will not be great for long distances ! OK for cities where you can plug in every 20 km or so. Already today, in Vancouver, over 70% of all new cabs are hybrids. But try to ride all the way to Abbotsford to visit Don Campbell .. good luck with an electric vehicle as it doesn`t even go 100 km on batteries .. yet !

 

[gwasser]

QUOTE (ThomasBeyer @ Aug 9 2010, 10:10 AM)
indeed .. because oil will be so expensive by then and has so many other uses than transportation or heat !



This world cannot function without oil !




To add to Thomas,



Electricity is not energy. It is a carrier of energy. The energy will first have to be generated. How do we generate electricity? Oil, gas and coal. Nuclear has the potential to become a more substantial contributor if the green movement and Nimby's allow it. Solar, wind and are not sufficient. Maybe geothermal but that is the neglected kid in the energy block.



I think that is the problem with a lot of people, especially those so loud about dirty energy. They have no clue how important oil and gas (and even coal) are and will be in the overall energy supply picture. And then there are all the products that use these commodities ranging from fertilizer to your computer keyboard. BTW I can't wait to have a wooden keyboard and splinters in my sensitive fingers.

 

[housingrental]

Re above
Don`t forget air pollution... In most of the growth area`s short distances are all that`s needed on a regular basis... and air quality is already a major issue... Anticipate environmental legislation to force a reduction in demand of oil not price levels of oil to prop up demand of alternates....
Electric car plus oil at $30 in the future.... as few will be driving cars that use much oil!!!

 

[GaryMcGowan]

I thought this post was about cash returns!
Certainly oil and gas will play a big part in our returns as investors. I`m very forward thinking and I agree that the electric car or an alternative to the gas car will be around in thirty years. They have them now! As mentioned above oil and gas is being consumed and there will always be consumers for it. At what level? who knows? I do know that billions of dollars is being invested for and around it. It is not going away anytime soon.