recording return on investment w/ no cash

[larryn]

Hello,

I am doing an overview of the performance of several investment properties (apartments) for my partner. Part of the report shows the cash return on the cash invested on a property. An example would be there is $20,000 cash invested in a property (balance of acquisitionis financed) and the property has a $2,000 cash return. I would record a 10% return on the cash investment part of the overview. I deal w/ principal pay down, depreciation, appreciation, etc seperately. Somej properties have no cash invested but have a cash profit. Such as a property that was purchased 100% by financing. Somej properties even have cash back from financing. I have a chart showing percent return on cash invested for each property w/ blank spaces where there is no cash invested but there is a return. It does not look right. Any suggestions to fill in the blanks?

Thank you

 

[ArcSine]

Strictly in accordance with how you're computing "return", the return on a property with zero cash investment is, mathematically speaking, undefined. (Some would say infinite, but that's technically incorrect.)

Even for a property with a nonzero investment, the "return" computation delivers an increasingly meaningless number as the cash investment shrinks toward zero. As a ridiculously extreme example, how about the return on a property that throws off a $5,000 profit, while the net cash investment is 25 cents? It's kinda like asking for my cash rate of return if I get 70 bucks a day flipping burgers at the corner deli.

I agree that the "cash on cash" return is a valuable metric in property investment evaluations, but it does have its limitations, as per above. Also note that two otherwise identical properties (same total cost, value, and cash flow) would produce two radically different "cash rate of return" numbers if they were acquired with different degrees of leverage---say, one was 95% financed while you put 30% equity into the other.

In most cases property investment analysts use a variety of metrics simultaneously, recognizing that each one has strengths and weaknesses in specific situations. One such metric, for example, is to separate out the financing effect. Look at the return from a property based solely on its cost, regardless of how that cost is financed. Then separately evaluate the NPV of the various financing options and packages available with respect to the property.

Most any decent book on real estate investing will give a pretty good survey on the popular analysis methods used in practice. At the same time, feel free to develop your own metrics---the only criterion is that it imparts useful and meaningful intel to you and your biz partner. (Although a quick skim of that book first might keep you from reinventing a wheel or two.) Best of luck with your project.

 

[larryn]

Thank you

That makes sense. Just to get a number I figured returns at $1.00 invested and it looked ridiculous.
I will enter "no cash invested" to show that cash on cash does not apply. I do figure returns on the investment in other ways. I figure cap rates and do periodic "comprehensive market analysis" to establish appreciation.
Thanks for taking the time to reply. It was greatly appreciated.

Strictly in accordance with how you're computing "return", the return on a property with zero cash investment is, mathematically speaking, undefined. (Some would say infinite, but that's technically incorrect.)

Even for a property with a nonzero investment, the "return" computation delivers an increasingly meaningless number as the cash investment shrinks toward zero. As a ridiculously extreme example, how about the return on a property that throws off a $5,000 profit, while the net cash investment is 25 cents? It's kinda like asking for my cash rate of return if I get 70 bucks a day flipping burgers at the corner deli.

I agree that the "cash on cash" return is a valuable metric in property investment evaluations, but it does have its limitations, as per above. Also note that two otherwise identical properties (same total cost, value, and cash flow) would produce two radically different "cash rate of return" numbers if they were acquired with different degrees of leverage---say, one was 95% financed while you put 30% equity into the other.

In most cases property investment analysts use a variety of metrics simultaneously, recognizing that each one has strengths and weaknesses in specific situations. One such metric, for example, is to separate out the financing effect. Look at the return from a property based solely on its cost, regardless of how that cost is financed. Then separately evaluate the NPV of the various financing options and packages available with respect to the property.

Most any decent book on real estate investing will give a pretty good survey on the popular analysis methods used in practice. At the same time, feel free to develop your own metrics---the only criterion is that it imparts useful and meaningful intel to you and your biz partner. (Although a quick skim of that book first might keep you from reinventing a wheel or two.) Best of luck with your project.