Many new and seasoned Twin Cities duplex and multi-family property investors decide whether to buy a property based on the cash on cash return they can get in their first year of ownership. Simply put, they want to know what the annual positive cash flow is, as a percentage, when compared to their down payment.
This is an important measure when you first acquire a property and many people know to use it. However, if you’re an established investor, have you ever thought, years later, to look at the return on your equity in exactly the same way?
Let’s say you paid $200,000 for your duplex in 2009. At that time, it had an annual positive cash flow of $4000, and your down payment was 20 percent ($40,000). The cash flow, divided by the down payment gave you a 10 percent cash on cash return ($4000/$40,000).
Eight years later, the market has gone up. Your duplex is now worth $350,000. You have earned $150,000 in appreciation, and you’ve paid off just over $30,000 of your loan, as well as maintained the original down payment in the duplex. Totaled, you now have $220,000 in cash in the duplex.
Let’s say over that same time, rent has doubled, leaving you with a positive cash flow now of $8000 a year. This is great news. Or is it?
You now have $8000 in cash flow, divided by $220,000 in equity, resulting in a 3.6 percent cash on cash return. In other words, the cash return on your cash investment has dropped 6.4 percent, in spite of doubling your income!
What’s the remedy?
One path may be to refinance the property and take some of the equity out to purchase a second property. This may help increase your cash flow or, at the very least, allow you to have two properties rather than one where your tenants are paying it off for you and providing you with monthly income.
A second option in a hot duplex market may be to sell the duplex and do a 1031 exchange into either a larger multi-family or commercial property.
If you have a goal of your investments generating a specific minimum annual rate of return, it’s important to check the numbers annually. If you’d like help with the math, or an idea of value, call or email. I’d be happy to help you figure out if you’re money’s working as hard for you as you do for it.