When it comes to ROI aka return on investment, most property buyers and investors that I meet tend to ask me about the rental yield. For instance, anything more than 5% rental yield in Klang Valley is usually deemed as a good investment prospect.
However, a more seasoned investor would also tend to ask me about the potential Cash on Cash Return or Cash on Cash Yield when evaluating the potential of an investment property.
Cash on cash yield is a form of cash flow analysis when evaluating whether an investment property might be a good one.
To put it in the most layman explanation possible, it’s the physical cash you have in hand after 12 months, divided by the physical cash you’ve already invested.
In essence, it is an operating cash flow metric.
It is a great metric for helping us understand how much cash flow the property might throw off during an operation period.
The Cash-on-Cash yield is determined by dividing the annual cash flow of a property by the amount of cash put into the property (typically the down payment and closing costs.)
Total cash basically means any cash put into the property, which would include the down-payment, closing costs such as legal fees, stamp duty fees and MOT etc.
Cash on Cash Example:
Let’s assume James purchased a property at RM1,000,000, with 35 years loan tenure at 4.4% interest rate.
First and foremost, James needs to take into account the total amount of cash put into the property.
The major costs would include:
|SPA Legal Fees||RM9000|
|SPA Stamp Duty (MOT)||RM24000|
|Loan Agreement Legal Fees||RM8200|
|Stamp Duty on Loan Agreement||RM4500|
|Renovation and Furnishing Costs||RM30,000|
Total Cash put into the property = RM175,700
Annual pre- tax net cash flow
|Monthly Rental Income||RM3500|
Annual Net Cashflow = (Monthly Rental Income x12) – (Monthly Installments x12 + Monthly Maintenance x 12)
= (RM3500 x 12) – (RM4200 x 12 + RM400 x12)
= (RM42000) – (RM50,400 + RM4800)
= – RM13,200
Oh no! -7.5% negative cashflow! Does it mean this property is a no go?
At the first glance the answer seems to be a yes.
Well, the thing is, cash on cash return doesn’t paint the whole story with property investments. Moreover, these days it is common for the Cash on Cash Return to be negative, unless the property was purchase before 2010. It was so much easier to achieve positive cash flow back then.
Let’s suppose James manage to negotiate and secured a better deal for the same property at RM900,000.
This property is a short walking distance away to an MRT station and is near to major tourist attractions. James decides to convert the unit into an Airbnb short term rental property.
He charges 170 to 230 per night depending on season , which average to RM200 per night. Assuming it performs well and the occupancy rate throughout the year is 80%, which equates to 292 days, arriving at total income of RM58,400.
He finances the property with 90% loan, 35 years loan tenure at 4.4% interest, arriving at a monthly repayment of RM3,785.
|SPA Legal Fees||RM8,200|
|SPA Stamp Duty (MOT||RM21,000|
|Loan Agreement Legal Fees||RM7,480|
|Stamp Duty on Loan Agreement||RM7,480|
|Renovation and Furnishing Costs||RM38,000|
Note: Renovation and furnishing costs are increased to RM38000 for short term rental usage.
As an Airbnb based property, positive COCR is achieved. Given today’s real estate sentiments in Klang Valley, a COCR of 4.84% is not too shabby.
Hey, it’s cash into your pocket after all!
Nonetheless, I reckon most investors would probably be not too satisfied with this performance.
Is there a way to improve the COCR rate? What if the down payment is increased? Well, the only way to find out is to key in the figures and find out.
Let’s suppose James has an extra RM300k sitting in his fixed deposit and goes for 80% financing instead.
What if the margin financing is at 70%?
Well, the COCR would then arrive at 5.28%. Even if James were to buy with 100% cash, the COCR rate is at 5.54%.
As depicted on the above example scenarios, the Cash-on-Cash return reveals three important things:
The examples above illustrate how the percentage can decrease or increase when you’re financing vs. paying more cash.
In the examples shown above, increasing the down-payment increases the COCR at a very marginal rate. The increase in COCR rate is simply too little to justify the additional huge cash outlay.
So it better to keep the margin of financing at 90%.
As such, COCR can help you decide on how much to borrow depending on how the ratio matches your goals.
Cash-on-Cash return also tells you your risk of holding debt – you might at risk of not being able to repay the debt tomorrow if the positive COCR is too low or negative COCR is too high.
Do take note that although the COCR percentage increased in the no-loan example, it may not always happen this way in other scenarios. The listing price, monthly rental income, mortgage amount plus other factors, can result in the loan version achieving a higher COCR rate.
Written by Chris Seah.
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