CASH ON CASH RETURN – MAXIMIZE YOUR INVESTMENT EARNINGS
Maximizing the cash on cash return on a real estate investment is what all investors should want. People often wonder how others have done so well with real estate investing. There is often an assumption that people who have accumulated wealth through real estate investing must have started with a good deal of money, got in at the right time, inherited property or had lots of cash.
Many people who have created wealth in real estate have done so by being creative or understanding how to maximize the return on their real estate investment. Maximizing the return on real estate investments can be accomplished in a number of ways.
Many investors know that using leverage is a way of getting into real estate in a bigger way then just using available cash. Leverage is basically using borrowed money to buy the real estate. Buying rental property with the help of a conventional mortgage or negotiating owner financing are ways of using leverage. Leveraging your investment increases your cash on cash return.
You determine your cash on cash return by taking your net cash revenue (cash in minus cash out) and dividing it by the cash you had to use to acquire the rental property. For example, let’s assume you buy a 3-family house for $200,000. You have $40,000 as a cash down payment and you finance the remainder. Assume too, that the property generates a net cash flow of $1,000 a month, or $12,000 per year. Your cash on cash return is the $12,000 divided by the $40,000 cash used to buy the property. This gives you a cash on cash return of 30%.
Now let’s you had paid all cash for the building. Also, let’s assume your mortgage payment in the prior example was $1,000 per month. Now you wouldn’t have to pay a $1,000 per month mortgage payment. In this example, your cash increases by $1,000 per month. Therefore, your cash on cash would be $24,000 net cash flow annually divided by the $200,000 used to buy the property, or a cash on cash return of 12%. Still a good return, but not the rate that you get when you use leverage, as the 30% cash on cash rate of return in the first example indicates. The fact that you have used leverage (borrowed capital) in the first example shows that you have maximized the return on your cash investment.
As time passes refinancing rental property can allow the owner to take money out of the property and purchase more rental units. The ability to refinance a building and remove cash is a result of appreciated value on the property as well as paying down some of the original debt. Also, refinancing a larger percentage of the value of the building then what was originally financed increases the amount that can be taken out of the deal. In other words, if you originally financed 80% of the appraised value and you can now refinance 90% of the appraised value, you are financing an additional 10%. Even in a situation where there is no change in the value of the building you conceivably can to take out money through refinancing.
An investor can also obtain property that is turn-key and has positive cash flow. Turn-key is obtaining property that needs no work and little effort on the part of the owner.
The actual after tax return on any real estate investment can be increased if the funds used to acquire the property are within a Real Estate IRA, which can accumulate earnings tax free. In this approach financing can also be obtained to free up funds for another investment. Howerver, if you are using an IRA to buy the property and also have the property mortgaged you must be aware that there is a distinct tax treatment you must follow.