When performing the Cash-on-Cash Return napkin test, I won’t further analyze anything that is below 12%. The target is 15% and higher but if we can still hit our $100/month cash-flow minimum, we’ll consider it with a lower CoCR.
Cash-on-Cash Return or CoCR
CoCR = annual cash flow before taxes divided by total cash invested
The best way I understand CoCR is like this. … For the scenarios below, let’s pretend I have $50,000 in my Pensacola bank account. We’re going to make a lot of assumptions here, but remember this is just a napkin test.
Scenario 1: I pay $50,000 cash for a 2 bedroom/2 bath single family house that yields $700/month in rent and Cash Flows $300/month. Over the course of the year (assuming 100% occupancy) my Cash Flow is $3,600 (i.e. $300/month x 12 months). So I take that $3,600, divide it by the $50,000 I spent on purchasing the home and that yields a 7.2% Cash-on-Cash Return for this Pensacola house. Compared to the return I receive on my savings accounts, this is an improvement, but not what we’re looking for on a Pensacola real estate investment.
Scenario 2: I pay the same $50,000 as a down payment on a $250,000 4-plex multifamily property (most Pensacola banks require 20% down on a rental property). This 4-plex is made up of 2 bedroom / 2 bath (just like our single family residence in Scenario 1). Each unit of our 4-plex brings in $150/month in cash-flow. Less cash flow than Scenario 1 to accommodate for the mortgage payment each month. Again, assuming 100% accuracy for the year, we now have $150/month x 12 months x 4 units = $7,200. Since we used the same $50,000 as a down payment, we divide $7,200 by that same $50,000, giving us a 14.4% Cash-on-Cash Return.
Actually, if this were a real world scenario, Scenario 2 is within range of passing the napkin test and would continue on through our Tripod of Investing Criteria. It doesn’t hit the $200/month cash flow # just yet, but more due diligence will reveal if we can increase rents or add another source of revenue from the property to bring those #s up.
To compare, let’s say I just keep that same $50,000 in my Pensacola savings account. The current APR is <1% but sticking with easy math, let’s pretend it is 1%. My return on that “cash” is 1%, or, very horrible…only $500. Considering inflation rates, my return would actually be negative, but that topic is for another post.
Cash-on-Cash Return (used in another way):
- REI Terms: Cash Flow
- How We Use Our Adopted Tripod of Investing Criteria
- Purchasing Our First Duplex