Real estate in many areas of the country has finally surpassed the pre-recession pricing, and people find themselves with quite a bit of equity in their homes and rental properties. One of the biggest mistakes I hear about from unsophisticated investors is how much lazy equity is kept in coastal markets such as Seattle and San Francisco, due to a white-hot market with double-digit appreciation and a booming tech market.
Sophisticated investors are constantly looking at their numbers and making changes to their portfolios. In some cases, they know when to take their gains and sell. The saying “buy and never sell” will work, but “buy and evaluate your return on equity (ROE) prudently” will yield high returns and safer capital preservation.
There are many metrics that investors use to quantify the quality of their investments — COC, ROI and ROE, to name a few.
Cash-On-Cash Return On Investment (COC Return)
This is the pre-tax, year-end cash flow divided by the actual amount of the original investment.
COC is used to compare your investment with other options, excluding factions such as the use of leverage (mortgage), taxes, appreciation over time and mortgage pay-down over time. As time goes on and your investment goes well due to tenants paying their rent as they should and the home increasing in value due to inflation and market appreciation, COC becomes less relevant.
For example, if you purchased a property with $22,500 down payment and spent $5,000 on closing expenses and $2,500 for some touch-up paint and new carpet, you are all-in for an original investment of $30,000. If at the end of the first year with your rental property in operation you are able to profit $10,000 from cash flow after all operational expenses and debt service are paid, your COC return would be $10,000/$30,000 or 33%.
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