Cash on Cash Return - Part I

October 05

After my talks at the Property Investor Show, London, I spoke with a number of people who had been confused about my claim that a Cash on Cash Return of 25 per cent was achievable. In conversation, it became clear that I had not adequately explained the difference between Cash on Cash Return (CCR) and Yield.

Given that I consider CCR to be the single most important financial ratio in assessing a property deal, I think that I had better clear up any confusion.

Those of you who have downloaded my presentation will be glad to know that the calculations I am doing are the same - think of this newsletter as an explanation of, and expansion of, slides 9 to 13.

Gross Yield is a simple ratio. The only things that matter are the income (rent) that a property will generate, and the purchase price of the property. (Actually, things get more complex after a few years when the price of the property you paid is different to its current value, but for the moment, we will concentrate on the yield at time of purchase.)

Gross Yield is simply the rent divided by the purchase price. Let us imagine a property let out with no voids at 800 per month, and that cost us 160,000. The annual rent is 12 * 800 = 9600. So the yield is 9600 / 160,000 = 6 per cent.

Net yield is slightly more complex. It takes into account expenses APART from interest. So, to take the example further, the expenses might be:

• letting agents commission of 10 per cent plus vat of the rent
• insurance
• CORGI certificate
• maintenance

At this point, I will also make the figures more realistic by assuming that the property is empty for 2 weeks of the year between tenants. (With good research beforehand, you should not have voids this high, but with poor reserach it is possible to have months of voids!)

The rent for the year will therefore be 9232.

• The agents commission would be 1085 including VAT
• Insurance might be 200
• A CORGI certificate might cost 50
• Maintenance might come to 400 over the year

So the total expenses related to letting the property are 1735.

Subtracting this from the rent gives a net income before interest charges of 7497.

The net yield is this net income divided by the purchase price, so 7497 / 160000 = 4.7%

Cash on Cash Return is a more complex figure, and takes into account how the deal is financed.

We look at the net cash flow, after interest payments, and divide that by the amount of CASH we put into the deal.

Sticking with our 160,000 house, let us assume that we are paying a deposit of 15 per cent = 24,000.

In addition we need to add in the other costs of buying the house, perhaps 700 in legal fees, and 1600 in SDLT (Stamp Duty Land Tax.)

This means that we are putting 24,000 + 700 + 1,600 = 26,300 cash into the deal.

The fact we have put in a 15 per cent deposit means that we are borrowing 85 per cent of the purchase price. This comes out to a mortgage of 136,000. Assuming that we borrowed this money at 6 per cent interest, we would be paying interest of 8160 a year.

This gives us a problem. We are only receiving 7497 cash a year after costs, so after the interest as well, the property is costing us 663 a year, so the cashflow is actually negative!

The CCR is this -663 cashflow, divided by the 26,300 cash we put into the deal.

The CCR is therefore -2.5 per cent. Therefore, this purchase would only make sense if firstly you happened to believe that the market would rise fast, and second you were prepared to gamble on that belief!

See the November 04 newsletter about prediction, prophecy and gambling.

To acheive a CCR of 20 per cent, which is my hurdle rate (the target I set myself), you would need to achieve rent of 1500 per month on the 160,000 property...

... or buy the property that let for 800 per month for only 80,000.

Which strikes me as quite difficult. The good news is that there is a solution. The bad news is that the solution will have to wait for the next newsletter.

This is just the feature article from the October 05 newsletter. Subscribe for market comment, forthcoming events, and more.

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