A short educational vlog (Episode 10) by Randy, CFO/VP of Business Development at Freedom Real Estate Group, explaining real estate valuation metrics: capitalization rate (cap rate), cash-on-cash return, and a personal metric he calls “real cash on cash” (or “Randy Cash on cash”). Randy defines each metric, gives numeric examples (a $100,000 property producing $8,000 NOI; financed with $20,000 cash and $400/mo mortgage), and shows how the new metric treats mortgage payments as someone else’s cash flow, yielding a 40% ‘real’ cash-on-cash in his example.
What is up, everybody? I am Randy, the CFO and VP of Business development for Freedom Real Estate Group, family of companies. And today is vlog Episode number 10. All right. And we are dealing with a little bit of some winter weather out here, so I thought it might not be a bad idea to give you a peek out the window here in my office in Fort Mitchell. But today we're going to talk about cap rates. We're going to talk about cash on cash return. And then there's a new little metric I'm going to introduce, talk to some folks about it. So it may be familiar to some of you guys, but it's a metric I use when determining the value of a deal, whether we should do it or not. And I call it the real return on cash. So let's get into it. Alright, So a lot of folks are familiar with the capitalization rate, or as we refer to it as cap rate, right? That is the net operating income divided by the current market value, right? So if you have a property, especially when you're making a buy decision, right? So the current market value would be your purchase price and then you would take into account the net operating income. So the net operating income divided by the purchase price, that's going to give you your cap rate. And so if you have a property that's going to produce $8,000 in income and the market value is $100,000, then that cap rate is going to be 8%. Pretty straightforward. Now one thing to keep in mind, a lot of folks don't recognize this is that the cap rate is based on the current market value. So if you're talking about measuring the performance of something that's in your portfolio, you may have bought that a long time ago. And the cap rate based on what you purchased the property for is one number, but based on what the current market value is. So if you're examining the performance of your portfolio, make sure that you take that into account. So moving on to the next measurement, cash on cash. So this is a measurement of the amount of cash that we leave in a deal, then the amount of cash flow in that we have left over after we paid everything at the end of the year that we've had to pay. And so this number is any receivable rent, not receivable, received, received rent, and then any other type of income you might have, maybe laundry or parking or a garage or any of that kind of stuff. So all of the rent that you have in then minus your operating expenses, and then any cash outflows that might be outside of your P and L. The one that sticks out to everyone is your mortgage payment. Right, because we don't get to deduct the cost of our mortgage payment. So let's say that same example, we have $100,000 property. It is going to produce $8,000 in net income. Cap rate was 8%. But let's say now that I'm going to finance this deal, I'm going to put $20,000 into the deal to get it. And then same $8,000 in net operating income. And my mortgage payment, let's say, is $400 a month. So what I'll do is I'll take that 8,000, my net operating income, I'll subtract out that 4,800 bucks. And then let me do that math real quick. Let's see, we had 8,000, minus the 4,800 is going to give us $3,200. I'm going to divide that by the cash I had to leave in the deal. And my cash on cash right there is going to be 16%. All right, so we're pretty familiar with that cash on cash. Now, here is a new measurement. And it's funny, because I talk to investors all the time, and I mention this as a metric to gauge performance of a potential deal. I use it myself in my investing, but I don't know that anyone else uses this. So correct me if I'm wrong. I think I've landed on the real cash on cash. But I'm not above calling it the Randy Cash on cash. And what this does is it accounts for the fact that that someone else is actually making that mortgage payment. And what that means is that my net worth is going up. Right. I can't exactly put a mathematical equation on it. I can adjust for appreciation. I can adjust for the fact that my liability on that is going down and those kind of things. But I don't want to get that detailed into it. I just want to know how this is performing. And so what I do when I'm assessing the performance of a property, I will use this real cash on cash. And what that is is net operating income divided by the cash that I left in the deal. So in this same scenario, I will take the $20,000 that I have in the deal, and then I will take the $8,000 in net income that I made. Then I will ignore the mortgage payment because my liability is going down and the value of my property is more likely than not going up. And so in this case, that number is 40% 8,000 divided by 20,000. So give me some comments below. Feel free to ask me any questions. Alright. You might have noticed that quick edit there, but I wanted to start doing this. Thanks for your time today. We'll see you next time. And remember, live wherever you want, but invest where it's smart. See ya.
