The Money Mustache Community
Learning, Sharing, and Teaching => Real Estate and Landlording => Topic started by: FrugalSaver on January 02, 2017, 01:05:27 PM
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I'm trying to confirm if this is a difference without a distinction or symantics or what.
Typical I see cash on cash used for SFH or quad plex or less
I see cap rate used for multi family (typically > 4 doors) or commercial properties.
How do y'all see this?
As an example, commercial with a cap rate of 6% is typically considered decent but I would NEVER buy a SFH with a 6% cash on cash return.
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Cap rate = cash on cash when no financing is involved. Commercial and larger multi-families tend to sell in a range of cap rates. Cap rates are useful as rules of thumb for those products.
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Cash on cash is the return on your investment dollars on a particular property (you may or may not have a mortgage when quoting cash on cash, but typically it's financed).
Cap rate is for an area, and is the return on the average property in the area if it was bought with no financing.
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This example might help you, too. (Note that it agrees with Anotherreader and Arebelspy:
You have a $100,000 property which you finance with an $80,000 mortgage and a $20,000 down payment. Your rental income equals $10,000, your expenses equal $5,000, so your income equals $5000.
Your cap rate equals the $5,000 of income divided by the $100,000 purchase price, so 5%.
Your cash on cash equals the $5,000 of income divided by the $20,000 down payment, so 25%.
Note what Anotherreader pointed out: If you bought the property for all cash, your cash on cash return equals the $5,000 divided by your $100,000 "down payment" so 5%.. just like the cap rate.
Two other related comments:
Your true overall property-level internal rate of return (IRR) equals the cap rate plus the appreciation rate. E.g, if the cap rate equals 5% and the appreciation equals 3%, your property's internal rate of return equals 8%.
Leverage works in a positive sense when you borrow money for less than your project internal rate of return. E.g., if you borrow money at 4% and invest in a project earning an 8% project IRR, you get a big bump in your profitability... which will show up in your cash on cash return.