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A lot of duplex investors come to me looking to find a duplex with a big CAP rate. After all, the bigger the CAP, the better the return on your investment, right?
While this is certainly true, a CAP rate is not the best measure of a duplex. The reason for this is simple: the purchase price per unit is often higher than it is, say, with a 20 unit apartment complex, and yet, the duplex and the apartment rent for similar rates.
Generally speaking, the apartment building generates the greater return according to the cap rate.
When a duplex owner goes to sell, however, they have a big advantage over an apartment building owner. Thanks to financing options that require lower down payments, there are more buyers for duplexes than there are apartment buildings. This drives values up.
At the height of the real estate market, this meant very few duplexes had a cap rate greater than 2.
In my opinion, this makes the cash on cash return an investor receives from a duplex a better measure of value.
What’s cash on cash return?
Like a CAP rate, cash on cash return is simply a way to compare one potential duplex investment to another. Simply put, it’s the amount of cash left over after you’ve paid all of a duplex’s expenses (cash flow), divided by your down payment.
If you put $20,000 down on a purchase of a $100,000 duplex, for example, and that duplex had a positive cash flow of $2000 a year, your down payment would be earning a 10 percent cash on cash return.
Compare this return to the amount of interest your money would earn in a savings account.
On the other hand, if the duplex you were considering buying a duplex with a negative cash flow of $2000 a year, you would would be earning a -10 percent on your down payment.
Measures like CAP rate and cash on cash return are ways of not only comparing one potential duplex investment with another, but also of making sure your money is working as hard for you as it possibly can.
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When I was a kid, every now and then my parents would say, “let’s go for a drive”.
They never seemed to have a specific destination in mind. They’d just load us all in the station wagon and take off.
Gas was cheap, so I think it was their idea of inexpensive family fun.
Of course, nobody can afford to do that today.
Every now and then, some of the real estate “investors” who call me on the phone remind me of my parents in those early days.
They don’t seem to have a particular plan or destination.
For instance, when I ask them what kind of cash on cash return they want on their money, I am greeted with silence.
This is usually because they have no idea what I’m talking about.
Cash on cash return is simply the amount of money you take out of a duplex investment every year compared to the amount you put in.
For example, if a duplex has a positive cash flow of $5000 a year, and your down payment on it was $50,000, then your money is earning a 10 percent cash on cash return. (5000/50,000 = .10 or ten percent).
Now, if that same $50,000 was earning $10,000 a year in some other type of investment, like stocks, a money market account, or business investment, it would be earning a 20 percent cash on cash return.
So why would you ever move it into something that makes you less?
Conversely, if that money’s generating a lowly 2 percent return for you in a savings account, why on earth would you leave it there?
What’s your ideal return on your money– provided there’s not too much risk?
If you know that before you begin, you’ll never end up financially lost.
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One of the most common things I hear new investors say is their goal is to buy a duplex, pay it off, and live off the cash flow.
This is a mistake.
What? Isn’t cash flow everything?
Of course.
But there’s also something called Return On Investment or ROI. ROI is the ratio of money gained or lost on a duplex relative to the money you have invested.
For example, if you buy a $100,000 duplex, and put 25 percent down, you would calculate your return based on the amount of your down payment; $25,000.
If you held that duplex for thirty years, however, and paid off the mortgage, the amount of your investment would be $100,000, and you would calculate your return based on that number. Of course, that’s assuming it doesn’t go up in value at all over the next 30 years; an unlikely scenario.
I met with a married couple the other day who owned their duplex free and clear. The investment property is not only a considerable distance from their home, but as retirees, they have a genuine desire to simplify their lives.
Of course, like all sellers, they want top dollar for their property.
Read the rest of this entry »
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Real estate isn’t like a Rolling Stones tune.
A seller can’t always get what he wants, or needs, out of the Minneapolis duplex or multi-family property he’s selling.
The market determines the value of investment property; not the amount of capital gains tax a seller may have to pay when he sells, nor the amount of money he’s put into the property.
What contributes to value?
First, duplexes can be difficult to price because there are two distinctly different markets for them: owner-occupants and investors.
For today, I would like to discuss an investor’s perspective.
Unlike single family homes, duplexes are not valued by the amount of finished square feet, nor the numbers of bedrooms or bathrooms.
Read the rest of this entry »
