A WAY Better Metric than Cash on Cash Return
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- Опубликовано: 31 май 2024
- Cash on cash return is probably the most popular metric to use when calculating the viability of a new rental property investment. Why? Not only is cash on cash return super easy to calculate, but it also gives investors a good overview of what their realized return will be. But what about the unrealized return? We’re talking about all the equity that’s sitting in your property, just waiting to be used to make more money.
If you’re solely factoring in the cash flow of your rental properties, you’re missing a much bigger piece of the pie. This is exactly what Dave Meyer, VP of Data and Analytics at BiggerPockets, found out a few years after he started investing. Dave was smart enough to buy shortly after the housing crash of 2008, but unfortunately, he missed out on years worth of reinvesting he could have been doing, thanks to the equity growth in his rental properties.
Now, Dave uses a not-so-new metric to calculate what the true return on his investment would be, so he can multiply his dollar many times further. If you’re looking to scale your real estate portfolio faster (and smarter), stop using cash on cash return, and try using this instead!
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00:00 What's Better Than Cash on Cash Return?
01:29 Dave's Favorite Money Metric
02:45 A Cash on Cash Return Example
05:25 A Return on Equity Example
09:42 Using Your Equity to Scale Faster
One missed point. By pulling out equity you are increasing your LTV. This is important from an overall balance sheet perspective since you want to make sure you aren’t overleveraged at any given point in time.
11:00 you're not walking away with $50k. You're paying yourself back for the $50k you originally invested. Your new 20% equity is the "profit". You now have zero $ of your cash in the deal. Cash on Cash is to infinity and beyond.
BRRRR
I think this a very important tool to use down the road. But it opens yourself up to more leverage. It's going to depend on your risk tolerance.
I think doing this incorrectly and being caught on the wrong side of a recession can land you into some serious issues. Cash flow is my blood supply and The equity is my cushion if my market falls.
Leverage works well in inflationary environments with rising rents. But being overleveraged means betting that this environment will last in perpetuity is foolish.
Very well said Chris
Well said Chris.
Hmmm. I’m not too sure about this one. My reason for this is because the market determines your equity so therefore you are speculating using ROE. How about just using cash on cash return for your calculations and every six months to one year take a look at the houses in your area to help determine your equity to see if it’s a good idea to do a HELOC or cash out refi.
Thanks for your feedback LEON -- I think we actually agree here. The best way to calculate ROE is to periodically look at comps and estimate the equity value of your home! With that, you can calculate ROE.
I agree that ROE should be looked at in addition to Cap Rate, Cash on Cash Return, and even IRR if you really want to get into technical analysis. Even Net Present Value could be used. If you are going to use ROE, then I think you should also use ROA in conjunction. Then you can compare another property against what you are about to do. However, I think your example is a little basic but that's probably by design for new people. If they sell it, there are also closing costs you didn't account for. Then closing costs on their purchase and any possible rehab money. If you go conventional then a refinance is only 2-3% in fees, but it's more like 5% if you use an institutional lender who specializes in investment rentals. Long story short, the numbers in your example are off in my opinion. The biggest issue with ROE is that value is somewhat subjective and changes. It's not always going up. You should also be looking at the average Equity for the year if you are going to use that metric. I love using leverage to scale. If someone leverages at 75-80% during an inflated market, they could be in trouble down the road if they need to sell. Like ay investment, being prudent and thorough analysis are just as important as the cash flow and the metrics to analyze cash flow.
I am new to real estate investing. I pulled equity out and I am now building a guest house on the property. I am currently house hacking the main house and on my way to build the guest house.
1. House is being rented about 75% I stay in one room.
2. Guest house will create another stream of income.
3. Value of property increases.
My new mortgage is $1,100. This includes the new interest of the rates being hiked. @4.2%. The house literally pays itself and I can now use the guest house income to save up for another property. I work at a fast food place like McDonald’s and if I can do it. Anyone can.
Coming from a traditional finance background, Dave couldn't be more on point if he tried. When I got into RE investing I never understood CoC as a metric, I called it a "poor man's ROE" when I first heard of it lol. CoC ignores the opportunity cost of the equity you're building up as you make the mortgage payments. What's interesting is in a rising rate environment, cash-out refi's become even more important. Since yields are going up, it becomes more prudent to shorten your duration (more finance lingo) on fixed income assets. All this means if interest rates go up, you might not want to be stuck in lower-yielding assets, and cash-out refis are the RE version of reallocating for higher yield. Thanks for the awesome video Dave and BP!
Thanks! Good video and good investment metric!
One thing to remember, especially today, is that refinancing is not always a good idea, as rates go up.
Yet Another video on BP’s shift away from cash flow into speculation.
FYI good metrics never get “overused”. They’re either a good metric, or not. They don’t get worse after more people use them.
Thank you for this feedback, but I want to clarify that ROE (the metric I am proposing you use more than CoCR) is a metric to measure cashflow, and a better one than CoCR in my opinion. I am not trying to downplay the importance of cashflow in this video. I am proposing an alternative way to measure it.
I agree. Good metrics never get overused. But it's great to have more tools in your tools box to understand how your investments are performing. That's never a bad thing.
The thumbnail says to stop using Cash and Cash return formula, but that’s not what the video is teaching. CoC return is a metric used to measure how well the property performs in the first year of the property to know if it’s a good deal. It was never a metric to use in the second and third years of owning the property. It’s to measure cash flow, which is calculating profits. The speaker in the video extended his definition of cash flow to include how profitable is the cash flow when it could be reinvested.
Reinvesting may not be everyone’s goal with cash flow. So this video is not for everyone. Like someone else said, the ROE method is another tool to use depending on your goals.
Agree, BP Likes to pivot away from their methods when they no longer work. CoC goes too low to make "good deals" BP needs a new way to market REI. LTR dont have great returns, BP starts promoting STR with they said for YEARS on the podcasts were too risky and not passive enough.
Thanks Dave, your perspective on real estate is among my favorites. Great content as always!
Outstanding information!! That was by far hands-down one of the best real estate best videos I have ever watched!!!
Excellent video, thank you for making this very easy to understand!
Appreciate this as always. ROE definitely changed my opinion on the yield of my return. As investors, we should always strive to maximize the available wealth we have. Thanks Dave!
This is a helpful way of allocating cash and observing your cash flows.
Great work here Dave. An interesting thought exercise is to try and apply a five step Dupont analysis to the portfolio. It raises question as to which ratios are holding their own and which are deminishing. Thus, as you pointed out perhaps needing adjusting. Good work!
Good stuff but this is why I hypothecate my equity out instead of doing a refi. Great video!
Super risky, after cash out refinance, not only the loan size increases but the monthly mortgage payments increases too, therefore diminishing the monthly CF on the 1st property.
I see what you mean, but how do you buy additional properties then? Sometimes saving the cash flow when you have one or two properties can take forever to save up for another deal.
Don't like deals that rely on market or equity appreciation...that's the stock market. Those terms are excuses....if ones portfolio was like that, then one is slave of the portfolio.
Show us your example. If you only have a few years left or even 5 or 10. Taking it back to 30 years plus $200k isn’t a big deal. You buy properties with the $200k. This increases your cash flow. Equity in homes is dead money unless you sell it.
I'm a novice investor at best. This is info is great. I'm going to apply this to a home I'm looking at purchasing for my this year. (I've been renting to long.) And revisit this method of using ROE method to build on for my future investments. Great info thank you.
Excellent analysis to apply in my investments from now on! Very specific, thanks!
I made a very good move (scared to death but worked!) sold one property and bought 3 cheaper ones but that adding up profits, the 3 new ones are bringing TWICE as the more expensive one!
What area do you invest in? If you don’t mind me to ask. Thanks
Great video!
Thanks
I feel like there is somthing missing. Can it be taken into consideretion the difference in market forces for a year over year comparison? Meaning the 6k in year 2 is not based on the same facotors as the 5k in year 1. Not just inflation, but home values, supply and demand forces, and other factors that led to obtain that number.
Really like the video, I believe equality is stronger way to build wealth in long run!
You explained this beautifully. great work and thanks for the clear information, Dave
Glad it was helpful!
Interesting, but: what is not discussed here is that "equity" if you sell, will be reduced by closing costs of roughly 8% to 10%; OR if you refinance, most lenders will only lend 65% to 75% on a cash out refi. So "equity" should be reduced conservatively from a simplistic "market value" less debt.
you need to take those costs into account if you are planning on selling. Closing costs, agent fees, taxes.
Hmmmm. Keep the podcasts/videos coming cause it forces looking at the same "thing" from different perspectives. Agree w/ most of the pessimists' comments. In your example, seems that the unmentioned paydown (after 3 yrs) is offset by the closing costs (and potentially getting approved for less than 80%). So I guess that's a wash. Seems that your hypothesis applies to particular mkt conditions. Ex: would/could you pull equity out as the mkt turned down? The downturning mkt (still more likely JMO) would put downward pressure on rents (employment rate would probably go lower) at exactly the time you were incented to raise the rent. In your example, assuming 4% on the original and refi (current mkt conditions - totally unlike a few yrs ago) that's about $200/mo more. In today's mkt property pricing, I'd spin up the example by at least a factor of 3, translating to an ADDITIONAL PI of $7200. All of which illustrates my point that you will eventually bump (some might say crash) into a rent ceiling. So the second condition under which this hypothesis seems to apply is not only a rising mkt but one in which rents are still commensurate with local rent/income pressures. Not all mkts are, say, silly cone valley and Seattle mkts. I guess I'm a pessimist that incomes are going to continue to drift up cause most companies will undergo a retrenching in the next few yrs due to downturned stock prices if for no other reason (i'm expecting stagflation, personally).
I guess where I'm coming out of the points everyone has made is that this perspective is more difficult to justify in current mkt conditions. Seems that ya really gotta find an exceptional deal that allows for pulling even more equity out of a current property. If I pulled equity out of a property today, I'd be more tempted to do it as I convinced myself a recession is hitting (implication being buy next prop at a lower mkt price). I know that's not your or Dave Greene's outlook. Just sayin'.
How do you get a loan with out putting anything down?
Is it a collateral loan?
Thanks for the video! But why didn’t you talk about taking out a HELOC to get the equity out? I’m actually going through this process myself right now. I currently have a building that performs a cash on cash return on investment of 30%. I make $12,000 a year with $40,000 invested. I purchased the property for $290,000 it is now worth $350,000. I owe $240,000 on the loan. If I sell I would get about $85,000 cash, based on 7% closing costs. But, I wouldn’t sell because it would be near impossible to find a 30% CoC return on investment again. Therefore, my plan is to take out a HELOC with an 80% LTV ratio, so that I can access that equity instead. I don’t have to do a cash out refinance because I don’t need the money right now. If I would do a cash out refinance I would have to pay closing costs and my mortgage payment would increase, lowering my CoC. Taking out the HELOC with no closing costs, keeping the current mortgage payment the same, and having $40,000 line of credit ready to be used whenever the next opportunity pops up sounds like the right deal to me.
Armando - it depends what what you use the money for. If you use that HELOC for purchasing, it's not a good idea because it's variable rate. If you use it for down payment or construction costs on something you are refinancing in a short turn around, then it's fine. I just did a cash out refi to purchase another property, therefore maximizing both CoC and ROE in my portfolio.
Love the new intro
As a new investor, I am currently analyzing a potential deal. My CoCROI is only 0.5% but the area is appreciating fast. Most deals will show an increase in equity over time, so how do I use ROE to determine if this one is a deal worth pursuing vs others? How long should you allow equity to build up before pulling it out? Thanks, Dave!
.5% ROI is not a deal :-D If you depend on appreciate to lift that deal, you're going to be burned eventually.
But is it still wise to cash out refi at a higher rate than you originally had? If the rate is lower it's a no-brainer. If rates are increasing, should I be nervous about this strategy? It puts pressure on the next investment to be a really good one. I've done this before and I'll do it again, but I definitely hear Dave Ramsey screaming at me.
Anne, Dave Ramsey is crazy about consumer debt. There are a lot of different strategies to build wealth out there. Leverage is a tool and should be used only at the proper time for the proper purposes to avoid getting hurt. This video is just an example of another tool to measure your performance. As an investor you can decide how to use info like this
But this is assuming you are paying the loan down yourself? If your cashflowing and having the tenant pay the loan , doesn't that add to your return?
Hi Marco! This assumes you’re tenants are paying the loan which does add to your return! That one of the ways you build up the equity I am talking about in this video.
Good stuff! (I'm dropping a comment for the algorithm 👍🏼)
If you haven't spent the time to understand basic asset valuation, portfolio management theory, TVM, and basic fixed income analytics go to the many free online finance classes that you can audit. If you watched this and feel you gained a real insight, You are to whom I speak. Great that BP has offered this, but sad it's taken all this time. Basic finance has nothing new to offer, but it will raise Your level of insight and risk assessment far beyond anything BP will offer you. The math isn't hard and Excel does it all for you now.
As mentioned below, a basic understanding of finance explains the comment below about IRR in a low rate enviroment vs Yield in a rising rate enviroment and why the commenter made his distinction and comment on speculation. If you know you know, if you don't it shows. Careful who you take advice from.
I have one question about cash out refi.
First loan amount 160k
Then after refinance i get 250k -50k=200k
Wouldnt my total.loan amount be 160k+ 200k
Then i repay the 160k amount from.200k and now my total loan amount= 200k ?
you getting a loan on 80% of new appraised value which is 200k out of 250k. You paying off 160k previous loan and putting 40k in the pocket, your new loan is 200k as mentioned before.
ROE is not substitute for CoCR. CoCR is non a discounted cash flow metric for ROI. ROE is not a discounted cash flow technique such as IRR and NPV. ROE is not a ROI calculation. all ROI calculations involve cash flows not equity. equity from asset price inflation is not realized or recognized as a cash flow until the asset is sold. equity from paying down the mortgage is not realized or recognized as a cash flow in until the asset is sold or the loan is refinanced. ROE should be used in conjunction with CoCR and IRR and NPV and not a substitute for. they all measure something a little different. ROE measures cash flow in performance compared to the assets equity not compared to the original cash investment in the asset or cash flow out. in several places he confuses net income with cash flow. they are distinctly different. they are not interchangeable. they come from different financial statements. net income is reported in the statement of operations or what most people call the profit and loss statement or income statement. cash flow is reported in the statement of cash flows. ROE is a valuable metric. as your ROE decreases assuming cash flow is increasing or constant, then the metric could indicate the equity from asset price inflation is increasing very quickly as a faster rate then cash flow is increasing. as he points our your equity is working less efficiently. it may be a good time to refinance the loan to 80% LTV pulling out cash for investment in new assets. this will reset the denominator in the ROE calculation to 20% equity and immediately increase the ROE or as he points out your equity is working more efficiently generating more cash flow for less equity.
again, don't confuse ROE as a substitute for CoCR or IRR and NPV. those metrics measure different things.
There is something wrong here, you do not have 50k in equity at the beginning. this is mistaken because you added the 5k of closing costs, and that is not equity. Nonetheless, a lot of value.
Translation: cash on cash doesn’t work anymore with such a skewed market
Many bigger pockets hosts started investing during the last financial crisis. Coincidence? If cash-on-cash return is too low, the market is too crazy. Stack up cash instead and wait for the next cycle. This ROE method means you are increasing debt and destroying equity. Dangerous. Sounds like a Congressional budget plan. Debt. Debt. Debt.
Shut up Dad! :-D You still need to make sound investments regardless - if you are speculating that market is always going to go up by 15% you're going to be burned. Your deals need to cash flow no matter what. You don't want to be left holding an empty paper bag. Having at least 20% equity is a way to make sure that in the case of a downturn you're not underwater.
@c-money would you rather have your equity in your bank account from selling or a cash-out refinance?
or would you rather have your Equity stuck in a property and at risk to get wiped out when the market turns.
@@johnnyb33good21 Personally I have a balanced approach 1/3 in properties, 1/3 in cash, 1/3 in stocks. Inflation is making the cash worth less every year, but making the properties worth more than inflation each year.
Maybe it's the way the copy for this video was written that makes it worse, but it seems to imply that the investor plans to use only CoC metric forever and is completely unaware their property is creating held equity. I don't think anyone who has played football would use the same play on first and then from their own 25 as they would 4th and goal. Likewise, I don't think there are many investors who are using CoC as a forever metric and are more likely using it to make purchasing decisions.
Is your $5k cash flow example per Month? Or is it per Year?
it's annualized so per year
@@johnnyb33good21 Thanks!
If 10% Cash On Cash return considered good or acceptable... what is a good Return On Equity % to aim for?
a 10% CoCR is really good!
@@biggerpockets I don't think you read my entire question. If 10% CoC is good, what would you aim for in RoE??
@@AberrantArt The idea is to compare like in 2nd year ownership what is the ROE of keeping the property vs selling it and reinvesting into another property. If you compare a property you already own ROE to another potential deal's CoC, if the CoC is higher, than you'll make more money on reinvesting into the new property.
@@christobar thank you, I understand that part already. But thank you for explaining. I should have said, what is a good ROE to keep and when is it time to sell? I compared it to the general rule that 10% CoC is good, and 20% is amazing, 5% or less is too low. So at what point is it time to sell?
One of the rare times I don’t agree.
You are using your IRR and thinking it can be used to determine yield.
Forgetting IRR is easier to get for the last few years.
And yield is easier to get for the next few years.
Thanks for your feedback -- can you please explain your disagreement? I am curious about your opinion, but this video doesn't address IRR. Can you please elaborate?
It sounds like you're recommending using a combination of cash on cash and return on equity, not throwing out the cash on cash number all together.
That’s right but the basic idea is: use return on equity. At the time of purchase return on equity and cocr are the same thing, so you can call it whatever you want. But ROE is the better metric over the lifetime of your investment.
What this doesn't take into account is taxes on capital gains and paying back depression. Which you will have to pay back at somepoint.
Unless you hold these properties and then will them to you kids... who will never have to pay captical gains or repay the depression.
These are both short term thought process... if you are a true long term thinker, you will never sell your properties to get the equity to reinvest it somewhere else.
You can continue to defer these taxes using a 1031 exchange. You will, however, likely lose a decent portion of equity to realtor fees and closing costs, which is a pretty big bummer
Please record better audio.
This method works great on excel in a perfect world, not in the real world, what you describe is how to make investors poor and lose all that they have eventually
how does this make them poor?
If they sell they can access their Equity and if they Cash out refinance their harvesting the equity & keeping the asset and using the equity to then again Leverage to maximize returns
In this scenario you really only have $50K in gained equity. the other $33K was your portion so it only makes sense to me if you do this math based on the appreciation of the property minus the sale price. I like where you're going but the math is muddy to me plus this equation goes away in a depreciating market.
If you are using CoCR then you are correct. By looking at the return through equity, the original 50 + built up equity is your CoER. Your Equity is a combination of initial investment AND growth. This example is for simplicity sake to show the concept. Of course there are multiple different factors involved in decisions like this.
Honestly I didn't get what the author is trying to do. But I wanted to comment on where it all leads: real estate investors are trying to come up with new formulas counting appreciation and principal pay off to justify their investments in front of lenders.
this whole thing stops making a lot less sense once the capital gains tax enters the chat
I see what you are doing here, but digging this deep also means you need to examine the debt structure. If you invest at 4% and pull cash out at 5% will the cash on equity offset the cash on cash? Great video!
You are giving some dangerous advice. Cash on cash is just that: the amount of net cash you are making compared to the amount of cash you risked on the investment. Return on Equity is subjective because it reflects what you believe is the amount of equity you have in your property based on what you believe your property will sell for. Your equity is like unrealized gain: it's not real until you sell the property or borrow against it. And as we are currently seeing, your equity can decrease. Therefore, I show my clients what their Return on Equity may be in the future based on a set of assumptions, but I ALWAYS emphasize that Cash on Cash ROI is what is 100% measurable and what ultimately matters.
Algorithm
I get that but your job isn't going to give you a pay raise so...
Clickbait title
im sorry u totally lost me on the 3 year scenario
I disagree with your method, your math is far fetched and incorrect, also did you include costs of refinancing, the rate changes and that the lender only gives you 80 percent cap. This video is not informative and dumb honestly
Thanks for your feedback, we believe the math is correct but if there is something specific you think is wrong, please let us know! As for the costs of refinancing, that is not a factor in calculating ROE, but you're correct that those costs should go into a determination of whether you should refinance or not. This video is about calculating ROE though, so there is no need to include those costs.