Cash on cash return is the most important factor when investing for financial freedom. Every dollar you invest needs to return the highest annual cash flow possible. This provides more cash every year to invest until you do reach the goal of being financially free.
WHAT IS CASH ON CASH RETURN?
Cash on cash return is how much cash you receive, divided by how much cash you put in. Investing ten dollars and getting two dollars of cash flow every year is a very solid 20% cash on cash return. Getting five dollars of cash flow for every ten dollars invested would be even better. That would be an absolutely incredible 50% cash on cash return. Clearly if both those investments had the same amount of risk you, would put all your money in the investment providing the 50% return. With real estate investing, there are ways to achieve this and even better.
What if there was a way to obtain annual cash flow with ZERO of your own dollars left in your investment? Or better yet, to have additional cash in hand AND annual cash flow? It may sound too good to be true, but it’s not and I have done exactly that multiple times. It will take some cash up front to achieve. But through adding value to properties, it is possible to achieve infinite returns.
WHAT IS A VALUE ADD PROPERTY?
Value add properties are often where you can make the highest returns and accelerate your timeline of acquisitions. Value add properties are essentially a flip and hold strategy. Properties with significant amounts of deferred maintenance and dated finishes are often incredible opportunities. They provide the highest returns, and potentially even infinite returns. That’s right, it is possible to achieve an infinite return. Stick with me and I’ll explain how, but we need to start with what makes a good value add property.
FINDING A GOOD VALUE ADD OPPORTUNITY
Identifying what makes a good candidate for a value add property first starts with your market knowledge. Let’s say you find a dated three bed, two bath house with a lot of deferred maintenance. First thing you need to know is what is the range that unit rents for in the area. If the range is wide and it is currently renting toward the bottom of the range, it might be a great opportunity.
It’s all about how much the rent can increase if the unit is remodeled. If the answer is not much, then it’s not a good value add property. That doesn’t necessarily mean it’s a bad investment. It’s just not a good value add opportunity. Sometimes the rents won’t increase much and there’s a lot of work that needs to be done. In that case, all the deferred maintenance should be addressed as part of the negotiation. If the rent can be increased significantly, it could be a great value add property. It all depends on how much the remodel will cost.
The second part of what makes a good value add opportunity is the cost of improvements. Costing out the remodel is where some people get in trouble. Make sure you are accurate in your numbers and account for everything, including carrying and closing costs. You’ve probably heard stories of people, or have seen house flippers on TV, who say they are going to complete the project for a certain price, but end up spending twice as much. Or they think it will take 3 weeks but it takes them 3 months. Don’t be that person. Make certain your numbers are accurate and that you have a healthy contingency buffer. Typically I factor an additional 20-30% over what I think it will cost to cover any overages or surprises.
IS IT WORTH IT?
Finally, put the two parts together. How much will the improvements cost, and how much will the rent increase because of it? Let’s say you were able to purchase a duplex for $100k that rents for $650 per side. Then you put $20k per unit to remodel, for $40k total renovation equaling $140k total. Now you can rent it for $1,000 per side.
How does that compare to how much you would have to pay to achieve the same rent from a unit that didn’t need work? If a move-in-ready property was available for $150k, and achieved the same $1,000 per side rent, that’s the better deal. The additional $10k in cost outweighs the time and effort for a major remodel. Especially given that $10k could easily go away if a surprise item came up during renovation. But if it would take $200k to buy a move-in-ready property generating $1,000 per side in rent, then buying the property that needs the renovation allows you to gain the same amount in rent for $60k less. Not only would you create 60k in instant equity, you would also get a huge return on your investment compared to the market.
TRANSFORMING A PROPERTY IS ALSO FUN
Turning a property around is also very self- gratifying. Seeing a property completely transform and achieving its full potential because of your vision and work is an awesome process. Sometimes it may be a full gut renovation while other times it may just be cosmetics. The more work to be done, the greater the potential to add value and get the property at a steal. Sellers and buyers alike will understand the amount of work needing to be done. If it is as simple as slapping a new coat of paint on and replacing the flooring, the discount won’t be as deep. When everything needs done. that is where you can find huge potential to add value. That is usually where you get the property at a deep discount, and increase the rents by a large factor.
Make sure that you update the exteriors to match what you’ve done on the inside too. Potential tenants care about the curb appeal as well as the interior space. A little landscaping, new doors, and paint can make an enormous difference.
FUNDING YOUR VALUE ADD
You may be thinking this all sounds great, but that you can’t afford a down payment and a major remodel. That may be the case, but there are other ways to get this done. Always try to think about how you can do something, not why you can’t. Find out if your bank would be willing to lend you the cost of the purchase and the cost of the remodel with a percentage of the total down. Then you don’t have to pay for the full rehab out of pocket. And you cover the entire cost through traditional financing. Maybe you have to find an investor or hard money lender. There are several ways to get creative in financing.
Ok, so it’s simple and easy to see how value add properties are a way achieve much higher returns than buying something already done. And that’s fantastic by itself. But what if you could achieve an infinite return? Well, you can!
THE MAGIC OF CREATING INFINITE RETURNS
The magic comes after the work is done. Let’s assume you bought that property for $100k and put $40k in renovations into it. Thanks to your work now the property appraises at $200k. If you hit those ratios, all you have to do is do a cash-out refinance at the new value. Banks usually give 70-75% of appraised value on an investment property, some will give even more. Let’s say you cash-out refinance at 75% of the value. That means the bank will give you $150k, which you get all tax free! This will pay off the original purchase, pays back the renovation cost (however you financed it), PLUS AN EXTRA $10,000 CASH!!
Not only did you get all of your investment back, you now have $10,000 more in your bank account than before you bought it! AND you have a rental property that continues to provide cash flow going forward. And with zero cash in, that is an infinite cash on cash return. Plus you don’t have to wait and save up for the next one. You have all the cash you started with plus some to get the next property. Value add properties do require more work, but there is no way to do better than an infinite return!