The one calculation that changed my life that I never learned in school

Like most of you I served my twelve years in K-12. Additionally, I spent another two years earning an associate’s degree in electronics and engineering. Then I moved on an achieved a bachelor’s and master’s degree in business.

So I have spent a lot of time in the education system.

In all of those hours and years in classes, I never learned this one equation that made me a millionaire.

Cash on Cash return is the one calculation/equation that changed my life.

What is it? In any investment, but I am talking specifically about real estate here, because that is how I used it to become a successful real estate investor.

You have to put up money or some kind of other resource to be an investor in it. You have to give up something, to get something. We all know this.

Cash on Cash return is the amount of money you invest and the returns you can expect on an annual basis to receive on the investment.

Here is a simple example that doesn’t include all the specifics, but I want to give you something to consider.

If you invest $100,000 dollars and it gives me a 10% cash on cash return in a year. It would provide me $10,000 a year back on that investment. I invest $100,000 and I get $10,000 in return.

In the case of real estate you invest a percentage, usually 20-30% of the value of the property, but you now own 100% of the property.

Real Estate is one of the only investment opportunities where you can invest such a low percentage of the value of it, and own all of it. The rest of the money comes through a loan. This is also called leverage. Which we will talk about another day.

Now the simple example I provided you above didn’t include all of the other specifics that you have to consider when making this investment.

Things such as loan payment, insurance, taxes, maintenance of the property, management, etc. So you must include all of these expenses in to the equation to get a full analysis of a cash on cash return.

Lets see a full example here:

Property price: $250,000
Investment (20%): $50,000
Mortagage/Loan: 5% interest rate amortized for 30 years: $1370, $16,440 annually.
(More context here: Why 30 years not something shorter. Well this would depend on your strategy, but in the world of real estate it is all about cash flow. So by extending the payment out over 30 years you can increase your monthly cash flow, because your payment is smaller. Again, real estate is one of the rare businesses you can do this in)
Property taxes (1% of value of property): 1% of $250,000 = $2,500
Insurance (depends, but conservatively): $1,200
Maintenance (5% of revenue):
Vacancy (3% of revenue):

How much can you rent it for? This depends not he area obviously. And there are a lot of resources to help you determine market rents such as rentometer (website) or you can call around. But I am old school, and I like to use the 1% rule. It is simple, and over the last couple of years in this crazy market it has been tough to find properties that can earn 1%, but you still can.

Gross Rent (1% of the value of the property): 1% of $250,000 = $2,500
Annual rent: $2,500 X 12 = $30,000

One of the things to remember here is this. Do all of your calculations on yearly basis.

So lets put it all together here:

Property price: $250,000
Investment (20%): $50,000
Annual rent: $2,500 X 12 = $30,000

Mortagage/Loan: 5% interest rate amortized for 30 years: $1370 (monthly) $16,440 (yearly)
Property taxes (1% of value of property): 1% of $250,000 = $2,500
Insurance (depends, but conservatively): $1,200
Maintenance (5% of revenue): 5%/$30,000 = $1,500
Vacancy (3% of revenue): 3%/$30,000 = $900

$30,000 (gross rent)-(expenses) – $16,440 – $2,500 – $1,200 – $1,500 – $900 = $7,460

So the amount at the end of the year you would have left us $7,460 dollars. And how much did you invest to earn that $7,460 dollars? It was $50,000, your downpayment to get the loan.

So what is the cash on cash return? $7,460/$50,000 = 14.92% but lets round it up and say 15%.

This is only one part of the equation though. Something we will talk more about in later posts are the other benefits of owning real estate. Things such as the tax implications, especially if you have a w2 job. Your loan pay down, your equity position increasing and how inflation helps you year over year when you own real estate.

I kept the math simple here. Some critics, may say, well, what if there is an HOA fee, or you didn’t specifically lay out the costs of closing, or lawn care, or management fees.

I get that. But with a single family home, most likely your tenant will do their own lawn care. If you self manage, which you might want to do on your first few properties you wont have that added expense.

Again, you can get more granular, and you should when you are analyzing a deal and whether or not it makes sense or not. However, I have found that more often than not, people analyze too much and never buy. You can analyze yourself into oblivion and never take any action. I don’t want you to do that. If a dummy like me he sucked at math can become a millionaire by following the above advice, anybody can do it.

If you do this over and over with multiple properties, single family, small multi-unit, commercial, big apartments, etc. You can see how this can grow.

Another thing we will discuss in later posts is how long does it take for you to earn the money you put in the deal back and what that means and how to use it.

So why did I never learn the cash on cash return equation in school? Was it taught and I missed it? And everybody I know missed it? I’m not sure. However, once I learned it. And once you learn it, it can change your life forever, like it did mine.

Cash on Cash return is one way to analyze an investment. But it is one strategy of many that you may consider as you start to invest your hard earned capital into real estate.

I look forward to expanding on this topic and example in future posts.

To your success and your future.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s