In relation to our last blog, I want to illustrate an example showcasing how to obtain a desirable return on investment (ROI) on an investment property. This is also known as a cash on cash return.
Let us say that you are pursuing a 10 unit multi-family building in Sherman Oaks, California. As an investor, you will want to purchase this property at a price that can facilitate your investment goals. Let’s say you want to obtain five percent (5%) return on your investment. Last week, we discussed that the net operating income a property produces is crucial to your investment decision. To recap, the NOI is a result of taking into consideration all income (rents), deducting vacancy factor and operating expenses (i.e. insurance, property taxes, maintenance, etc.). Our formula for this figure is as follows: NOI = Gross Annual Income – Vacancy Factor – Operating Expenses. These components will be crucial in determining your cash on cash return.
For the 10-unit building, you will want to issue a down payment that is to your advantage. However much down payment (or cash equity) you choose to expend will help determine that cash on cash return. Of course, figures on the property will be influenced by the city it is located in. If a 10-unit property in Sherman Oaks is selling for $1,750,000, you will want to consider this sample scenario.
Loan Assumptions
| Asking Price: | $1,750,000 |
| Loan Amount: | $1,137,500 (65%) |
| Down Payment: | $612,500 (35%) |
| Interest Rate: | 4.5% |
| Loan Amortization Period: | 30 Years |
| Monthly Mortgage Payment: | $5,763 |
Investment Analysis
| Rental Income: | $150,000 |
| Vacancy Factor (3%): | -$4,500 |
| Operating Expenses: | -$43,750 |
| Net Operating Income: | $101,750 |
| Less Debt Service w/ 35% Down (Annual Mortgage): | -$69,162 |
| Return on Investment: | = $32,588 (5%) |