Why Cash on Cash is King with Property Investors

The following article excerpt was written by W Darrow Fiedler, CCIM at KW Commercial in the USA, and is reprinted with his permission.  You can find more about Darrow at http://kwcommercialidaho.com/

Simple ideas are the easiest to understand and implement in life. This has been ratified over and over again as we have journeyed through life and studied those who have financially succeeded. Not just the wealthy but all successful investors in real estate have followed a similar model. So let’s take a look at what is working in today’s real estate investment market. Hopefully when you finish this article you will have an understanding that this is the best buyer’s market in real estate that we have seen in decades and will be willing to venture forth!

Capitilization rates (cap rates), internal rates of return (IRR), financial management rate of return (fmrr), gross rent multipliers (GRM or GIM), cash on cash (COC), return on equity, and so on, all provide a financial perspective for an investment property. It used to be that providing an investor with a multi-page spreadsheet was business as usual and they were impressed that such computations took into account their income tax rates, annual adjustments for income and expenses, as well as some sort of “appreciation” factor. It truly was a custom look at a potential investment and many properties were sold on that basis.

Today, the perspectives have changed, mainly because “appreciation” is now a moving target and frankly a non-entity in analysis. We use to think three-percent appreciation was very conservative, but what is it today? Your guess is better than mine. With appreciation loosing importance, vacancy factors under stress, expenses increasing, and prices falling or at the very least softening, just figuring the value of an investment property can be a challenge. In the past investors were happy with a six to eight (6% – 8%) capitalization and cash on cash rates, but things they are a changing and certainly for the better as far as buyers and investors are concerned. Financing has also become more challenging for lenders are reducing their risk by lowering loan amounts and requiring more security from borrowers.

Which brings us to the most valuable commodity in the purchase of real estate investment property today – “cash”. Those with cash are in the driver’s seat and those who can compound that with borrowing power rule the night. As a result, analysis has become very simple; investors are looking at and asking, “what is my cash on cash return“. This is simply calculated by taking the net income after debt service, of a property and dividing it by the amount of cash invested by the buyer. Since cash is the most valuable commodity in a transaction, investors are now looking at maximizing their opportunity and are looking for double digit returns, in the ten to twenty-five percent range (10% – 25%).

Yes, in order for someone to tie up cash in a real estate investment today the factor of “risk” has raised the requirement to a much higher cash on cash return than in the past, and with “appreciation” out of vogue, the only return an investor can receive today and possibly for several tomorrows is the “cash on cash return”.

Also see: Investment Real Estate Terms: Cap Rate & Cash on Cash Return

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