When buying an investment property, you have a couple numbers you can look
at to see how the property is performing.
Cap rate - NOI/purchase price
cash on cash - cash generated/cash invested
at the point of purchase, these numbers are easy to come by. How do you
perform such an analysis over time?
cash on cash includes cash generated which is "sheltered" by depreciation.
It can be considered a return of capital, as buildings do wear out.
So, each year, should you consider cash on cash as the cash generated
(including that sheltered by depreciation) / cash invested (including
principal payments made to amortize the loan principal)?
Should you consider NOI (net of depreciation)/cash invested (less the
depreciation return of capital)?
what should we be doing here?
Those concerns may be interesting and productive for those who have the
time and resources to spend on them, but I suspect they may be putting
too much emphasis on current performance of real estate investments, as
opposed to long-term appreciation. I get the impression it is sort of
like being concerned with the current dividends and short-term
fluctuations of stocks and mutual funds as opposed to long-term capital
A "buy and hold" strategy has much to recommend it in real estate as it
does in stock investment. Someone who ventures into real estate and
then quits after a few years for one reason or another is being as
unwise as someone who buys stocks or mutual funds and then sells after
a few years, tries to time the market, etc. One's time horizon is as
important in real estate as it is inequities, if not more so. Current
statistics that change from year to year are not the main concern.
Yes, that is true. If you invest in rental property, you have to plan
in advance about cash flow and allow for vacancies, repairs, etc. It is
best to make a big down payment, so that mortgage payments do not eat
up all the cash from rentals. If you can't afford a big down payment,
go for a lower-priced property where you can afford one. But that kind
of caution is not a lot different from investment in stocks and mutual
funds. It is generally agreed that you should not invest in equities
until you have paid off credit card debt and maxed out pension plans,
Investing in rental property is much the same as financing your
personal residence. People get into trouble, we know, when they buy big
houses with small down payments and large mortgages, and then
emergencies come along so they cannot keep up the monthly payments.
Better to buy a smaller house with a substantial down payment and a
lesser mortgage. The same for investment property.
I agree that you should get rid of a house that looks like it was a
poor investment for one reason or another. But that decision should be
made for convincing reasons, not because of temporary economic
conditions, a slow rental market, etc. just as you should not buy and
sell stocks on the basis of the temporary ups and downs in prices.
I understand "buy and hold", that's for darn sure. I also know that as long
as you are holding something, you should manage it well. so, annual
analysis is wise.
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The way I look at it isn't necessarily the way your CPA looks at it.
Do your taxes correctly. I find it easiest to lump all the recurring
expenses/income together and all the one time expenses/income
So I consider the monthly principal payment to be a recurring
expense. The principal (paydown) gain when I sell a one time income.
NOI doesn't really include tax benefits. Unless you are a high income
earner and own properties free and clear your real estate will
probably be in the low income brackets. Especially if you have
significant debt service. The really great thing about real estate is
that you can take on as much debt service as you like and make your
net income anything you want. Low or negative cashflow is the easiest
thing in the world to come by. The depreciation recapture is a one
time expense when you sell. The depreciation tax benefit doesn't
really show up in CAP or cash on cash return. You just know it is
there like icing on the cake. Of course you can define any metric you
want and include recurring depreciation benefits.
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