I recently talked about one of the bright line tests my husband and I use for real estate investing. We look for gross rental amounts of 12% per year. In other words, if we pay $120,000 for a property, we’ll look for something that can rent $1,200 per month.
Just to be clear, this is GROSS rental amount. If it’s financed, then there would be a mortgage payment reducing the net rental amount and even if wholly owned, there would be property tax, insurance, maintenance, repairs and possibly HOA dues, among others.
Your overall return would not be 12%.
I received the following question after I’d posted something about looking for 12% return.
“Very interested where you are getting 12% cash-on-cash return on your real estate. I am looking at the stock market to achieve that as well, but recently haven’t been able to do that. Have you found a way to do it in the stock market on a consistent basis?”
The 12% is gross, not net. So the ROI (return on investment will be lower). The other stat we’ve watched a lot in the past is COCR (cash on cash return). This is calculated by dividing the annual net cash flow by the total cash that is invested.
Let’s look at that same $120,000 property. In one case, let’s assume you pay cash and there are no other expenses. (I know that’s unrealistic, but I’m trying to keep the math simple).
We’ll assume it’s rented for the whole year and there are $2,400 of other expenses. That would mean there is $12,000 annual cash flow divided by $120,000, for a COCR of 10%.
That’s not bad at all!
Now let’s assume you get a loan for part of the cost, so you only need to put down $20,000. Your cash into the deal is $20,000. You have a mortgage payment now and we’ll just assume that plus expenses comes to $9,400. That means you have net annual cash flow of $5,000.
The $5,000 is divided by $20,000 would give you 25% as a cash on cash return. That is HUGE!
That’s how the power of leverage can work with real estate.
ROI, on the other hand, is calculated by taking the total amount of net cash flow by the total cost, some of which is from leverage and some of which is cash.
We look at the gross return, COCR and ROI in determining whether we want to invest. Which is better? Cash or leverage? It all depends on your own circumstances. That is no one right answer.
There are 5 big differences between stock investing and real estate investing:
(1) Cash flow,
(2) Leverage possibilities,
(3) Tax breaks,
(4) Appreciation, and
Cash flow. Real estate is set up to provide cash flow. There are very few strategies to provide good cash flow from paper asset investing. Usually you have cash flow from selling.
Leverage. You can get good mortgage loans. It’s possible to get margin loans against stock positions, but they’re risky and more expensive. And if the stock price drops you get cash calls due NOW and you could lose it all!
Tax breaks. That’s the thing about real estate investing I like the best. You can make money on real estate and pay no tax. Try that with stock investing.
Appreciation. Except for really low returns from dividends your main strategy for stock investing is appreciation. But it’s passive appreciation. There is very little you can do personally (and legally) to make a stock go up in value. There is a lot you can do to make real estate go up in value.
Control. More than anything else, I like the control I get with real estate investing.
So, in answer to the question, do I know how get these kind of returns with paper investing? Nope. I invest in real estate for the reasons above.