You can use cash-on-cash return to evaluate an apartment building.
Before conducting complex analysis of a potential investment property or making an offer to purchase a property, you can evaluate a property's investment potential to determine whether you want to consider it further. A property with good investment potential is one that generates positive cash flow and that meets your return criteria. You can measure a property's return by calculating its cash-on-cash return, which compares the amount of cash required to invest in the property to the amount of cash flow the property generates annually.
Instructions
1. Determine a property's asking price and estimate the total mortgage you will be able to obtain to purchase the property. For example, assume a property's asking price is $500,000 and that you could obtain a $350,000 mortgage to acquire the property.
2. Estimate the amount of repairs or remodeling the property will need before renting it to tenants. You can estimate the repairs yourself or hire a contractor to estimate the necessary repairs for you. In the example, assume the property will need $10,000 in repairs.
3. Subtract the mortgage from the property's asking price. Then add the amount of necessary repairs to calculate the amount of cash the investment will require. In the example, subtract $350,000 from $500,000 to get $150,000. Then add $10,000 to get $160,000 in cash that would be required to invest in the property.
4. Subtract the property's total annual operating expenses from its annual rental income to calculate its net operating income. Then subtract its mortgage payments to calculate its annual cash flow. Cash flow can be positive or negative. In the example, if the property generates $60,000 annually in rental income and has $15,000 in operating expenses and $25,000 in mortgage payments, subtract $15,000 from $60,000 to get $45,000 in net operating income. Then subtract $25,000 from $45,000 to get $20,000 in annual cash flow.
5. Divide the property's annual cash flow by the total cash required to invest in the property to calculate the property's cash-on-cash return. In the example, divide $20,000 by $160,000 to get 0.125, or a 12.5 percent cash-on-cash return.
6. Compare the property's cash-on-cash return with your required rate of return. If the property's cash-on-cash return is greater than or equal to your required rate of return, proceed with further analysis. If the cash-on-cash return is lower, the property likely will not have the investment potential you require. In the example, if your required rate of return is 10 percent, the property's 12.5 percent cash-on-cash return surpasses your requirements, so you would consider the property further.
Tags: cash-on-cash return, cash flow, amount cash, annual cash, annual cash flow, asking price
