Cash Flow vs. Cash-on-Cash Return: What Mistake Should Investors Avoid? | Real Estate Rookie Episode 308

TL;DR

Cash-on-cash return is more useful than cash flow alone because it compares a property’s annual profit with the cash invested to acquire it. In Real Estate Rookie Episode 308, Ashley and Tony explain this metric, evaluate low offers, discuss appraisal risks, and outline seller-financing calculations. Read on for practical guidance on analyzing deals and structuring financing.

Transcript

this is real estate rookie episode 308. and I just wanted to find really quickly cash on cash return because we're talking about this as a metric but for those that aren't familiar with that metric cash on cash return is a fraction and the top of your fraction you have profit for the year right how much profit did you generate over a 12 month time ... Read More

Key Insights

• Cash-on-cash return is a vital metric for real estate investors, measuring annual profit against cash invested, unlike mere cash flow figures.
• Understanding the difference between listing price and actual property value is crucial; negotiations can lead to significant savings.
• Using lines of credit for down payments can be risky due to variable interest rates; it's better suited for short-term funding.
• Appraisals ensure the property's value matches its sale price; low appraisals can require buyers to cover the gap.
• Seller financing can be beneficial; offering amortization schedules can help demonstrate potential earnings to sellers.
• Amortization and loan term are different; a longer amortization with a shorter term can be advantageous in seller financing.
• Appraisals are more art than science; two appraisers might value the same property differently, affecting loan approvals.
• The real estate market can shift, influencing appraisals and potentially requiring renegotiations or additional funding from buyers.

Questions & Answers

Q: What is the difference between cash flow and cash-on-cash return?

Cash flow is the income remaining after expenses, while cash-on-cash return compares annual profit with the cash invested to acquire the property. This makes cash-on-cash return a clearer measure of investment profitability than a cash-flow figure alone.

Q: How do you calculate cash-on-cash return for a rental property?

Divide the profit generated over a 12-month period by the cash invested to acquire the property. For a short-term rental, the invested cash typically includes the down payment, closing costs, and startup costs.

Q: What cash-on-cash return should a new real estate investor target?

The episode does not prescribe one universal target. Instead, investors should determine what return makes sense for their own strategy and evaluate each property using its annual profit and required cash investment.

Q: How low should a rookie investor offer on an investment property?

There is no fixed offer that is automatically too low because a listing price does not determine the property’s actual sale price. The offer should be based on the price that makes the investment financially sensible for the buyer while recognizing that other buyers may submit higher offers.

Q: Can an investor buy a property for much less than its listing price?

Yes, the episode describes a property originally listed for almost $400,000 that was purchased for $293,000 after months of negotiation. The resulting flip made about $40,000 because the buyers acquired it at a price that worked for them.

Q: What are the risks of using a line of credit for a real estate down payment?

A line of credit may provide funding for a down payment, but its variable interest rate can cause payments to rise. The hosts advise caution and describe this approach as better suited to short-term projects.

Q: What happens when a real estate appraisal is lower than the purchase price?

A low appraisal can leave a gap between the property’s assessed value and its sale price. The buyer may then need to provide additional funding or renegotiate the transaction.

Q: How can an investor present a seller-financing proposal?

The investor can show the seller an amortization schedule that explains the payments and potential interest earnings over time. The proposal should clearly distinguish the amortization period from the loan term and use terms that are financially workable for both parties.

Summary & Key Takeaways

• The episode emphasizes the importance of cash-on-cash return over cash flow for evaluating real estate deals, providing a clearer view of investment profitability.

• Ashley and Tony discuss using lines of credit for down payments, advising caution due to variable interest rates and recommending it for short-term projects.

• They explore seller financing, explaining how to calculate payments and pitch the benefits to sellers, highlighting the need for clear financial strategies.