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Cash on Cash Method - calculating returns on Property

Discussion in 'General Property Chat' started by sash, 9th Jan, 2016.

  1. sash

    sash Well-Known Member

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    Hi All,

    A lot of people focus on the growth of the property ..so lets say someone buys a place for 300k and it goes up to 400k....that represents a 100k increase or a 33% CG. I think this is very simplistic..and it not considering true Cash on Cash return.

    So what is the cash on cash return? Well lets look at two scenarios here:

    1. First house is bought for $120k ....the deposit is 12k.....stamps and other costs are another 5k plus a reno cost of 7k. Lets say it is sold for $180k and agents fees are $5k. The house was held for 5 years and was positively geared to the tune of lets 10k over the last years.

    2. Second house is bought for $300k...the deposit was 30k....stamps and other costs was $20k plus a reno cost of $25k. Lets say the house is sold for 450k and agents fees are 15k. The house is held again for 5 years and was neutral geared.

    On the surface it looks like option tow is the better buy. But if you use the Cash on Cash return method ...option 1 is the better buy. Why...let have a look.

    1. Options 1: the total capital costs is 5k in costs plus 7k reno cost but due to tax deductions it has only costed you 5k....plus another 5k for exit costs. So the total cost is 15k. Add that to the original 120k and you have 135k base cost...since you sold for 180k...your profit before tax is 45k. But you also made 10k positive income from the property over the 5 years. so the total cash return is 55k.

    Now for the cash on cash method. you add the total in/out costs plus your deposit it cost you 21k. Your profit before tax is 55k. So technically you had a return of 262% cash on cash return. That means using the rule of 72 your money grew about 18% per annum

    2. Options 2: the total cost 20k in costs plus 25k reno after tax advantage it would be around 18k plus 15k exit fees. So the total in/out costs is 43k. Add this to the original 300k you have a 343k base cost..since you sold for $450k...the profit before tax is 107k. But no money was made from CF....so total return is still 107k.

    Now for the cash on cash method applied to this scenario. Add the cost deposit to the original 30k deposit...you have 73k. Your profit beofre tax is 107k. So technically you have made 147% return on a cash on cash return basis. That means using the rule of 72 your money has grown about 7% per annum

    I believe using this method is really important as this conveys the real rate of return on your funds.
     
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  2. D.T.

    D.T. Adelaide Property Manager Business Member

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    I like this method.

    One of my examples
    29k deposit + 5k stamp duty + 0 lmi + 3k repairs
    Day after settlement revalue and extract 30k, used as deposit on subsequent property
    Nearly 100% return
    Positive cashflow
    Zoned for development
    Growth is just cream on top if it comes
     
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  3. sash

    sash Well-Known Member

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    Yes....but over time if there is no growth.....the money is left better in the bank.

    For example it looks lije you bought yours for 145k (probably semi)....if it grows say to 160k over 5 years and say you have 10k positive income it is not a great numbers.

    Here are the numbers.

    in costs 8k...out costs 6k...so base is now 158k. That leaves you with 2k profit plus 8k positive income in say 5 years.

    So a total of 10k out of an cash opportunity cost of 45k invested hard cash. That is a 22% return over 5 years. That is a 5% return. It is okay but for the risk and headache you might be better with bluechip shares or an term deposit. So another wards...why would you??
     
  4. D.T.

    D.T. Adelaide Property Manager Business Member

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    It is a house, zoned for development

    Which money exactly? Did you see the part where nearly 100% was pulled back off the table?

    Why is there an out cost?

    No idea where you got these numbers, I'm happy to go into more detail so that you better understand the concept if needed.
     
  5. sash

    sash Well-Known Member

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    The out cost is based on selling....till you sell the true value of a property is never known.

    Yes you can pull 30k out...but does that mean it is worth that much? The real test is selling it..
     
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  6. D.T.

    D.T. Adelaide Property Manager Business Member

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    Not concerned with testing true value, happy to go with what the licensed valuer says. Balance in bank account still went up by that amount and subsequently reinvested.
     
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  7. sash

    sash Well-Known Member

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    Well....the bank valuer valued my Tenambit property early last year for 380k....I bought it for 205 plus a 20k reno. There is no way it is remotely close to 380k let alone even 330k...it is more like 310-320k. I did pull out the equity....but if I was to sell it and I had spend the 60k over market unwisely...that could land people in a pickle.
     
  8. D.T.

    D.T. Adelaide Property Manager Business Member

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    Awesome result, well done.

    Only lands people in a pickle if they take on more debt than they can afford or if they're too negatively geared. If rent is paying for all of it, then that's a lot safer in my view.

    Remember that they value under (like in my example above) far more often than they value over.
     
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  9. Bullion Baron

    Bullion Baron Well-Known Member

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    It's a better return on the cash put into the deal, but there's no mention of the additional stress/hassle/time that would come with having to own and manage twice the number of properties for the same nominal profit.
     
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  10. Iamnumber5

    Iamnumber5 Well-Known Member

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    @sash agree with the way you calculate it.
    With that much yield and cg, that is the ideal scenario, definitely choose property 1, but it's not always the scenario in real practice. It's either you choose the yield, cg or balance of both. Occasionally we might get our hand on this type of gem. It is less likely that we can repeat the process. Happy to get some pointers from you, if you have successfully done it this way.:)
     
  11. Blacky

    Blacky Well-Known Member

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    I like @D.T.'s maths.
    He hasnt put any money into the deal...and gets money out of it.
    How do you calculate % returns when there is $0 down?

    @sash
    While I understand your logic - you have painted a biased picture.
    In example #1
    You buy for $120k
    costs are 20% (12k+5k+7k/120k)
    Value increase is 34% and you have +ve gearing of 8.3%

    Example 2
    You buy for $300k
    costs are 25% (30k+20k+25k/300k)
    value increase of 31% and no +ve gearing.

    Therefore you are not comparing apples with apples.
    You are comparing the possibilities of two seperate investments, rather than comparing two philosophies.

    I understand what you are trying to say though.

    Blacky
     
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  12. D.T.

    D.T. Adelaide Property Manager Business Member

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    Numbers are objective, feelings are subjective
     
  13. Bullion Baron

    Bullion Baron Well-Known Member

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    Time is a number.

    Additional work/hassles is not a feeling.
     
  14. sash

    sash Well-Known Member

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    No issue if you have good property managers.
    I used this as an example only. My preference is like this which a couple of ones in my portfolio have achieved.

    Bought for 242k in 2012 - 3 bd 1 bth 1 garage home in Shellharbour. Tipped in 5% of 12.5k plus stamps/legals of 8k plus 1.5k reno. Lets assume that it will cost 10k to sell. Also LMI was about 5k..so after tax allow cost of 2.5k. The value of the property is now 480k. It has been neutrally or slighly positive since day one.

    So the in/out costs plus 22k so the base lets say is 265k. So on a gain of 215k....it cost me 35k in cash. That represents 614% return on my cash over 4 years. I like these sort of properties the best.

     
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  15. Scott No Mates

    Scott No Mates Well-Known Member

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    Absolutely no idea what the cash on cash return is meant to represent.

    Scenario 1 has an NPV $11,135 & IRR of 12% vs option 2 NPV $57,641 & IRR of 8%
     
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  16. mrdobalina

    mrdobalina Well-Known Member

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    How did you work that out?

    Edit: my maths was wrong.
     
    Last edited: 9th Jan, 2016
  17. Scott No Mates

    Scott No Mates Well-Known Member

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    Assumed Discount facto of 15%, 90% borrowings, cf+ in yrs 2-5.

    1. First house is bought for $120k ....the deposit is 12k.....stamps and other costs are another 5k plus a reno cost of 7k. Lets say it is sold for $180k and agents fees are $5k. The house was held for 5 years and was positively geared to the tune of lets 10k over the last years.

    2. Second house is bought for $300k...the deposit was 30k....stamps and other costs was $20k plus a reno cost of $25k. Lets say the house is sold for 450k and agents fees are 15k. The house is held again for 5 years and was neutral geared.

    [​IMG]

    Assumptions:
    Discount factor - 15% (this isn't a development so I used a lower DF)
    100% borrowings (for simplicty say line of credit used)

    Although Scenario 2 produces a lower Internal Rate of Return, it will return more cash - even when Scenario 1 is upscaled to the same overall cost, Scenario 2 returns about $27K more cash.

    I have modified my original post from 90% to 100% to reflect true IRR calculation.
     
    Last edited: 10th Jan, 2016
  18. Leo2413

    Leo2413 Well-Known Member Premium Member

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    WTF.........
     
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  19. Scott No Mates

    Scott No Mates Well-Known Member

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    @Leo2413 - formatting is crook - I will repost when near my desktop confuser.
     
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  20. Johnny Cashflow

    Johnny Cashflow Well-Known Member

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    image.gif
     
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