Mar 20, 2017
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What is the Difference Between “Cash on Cash Return” and “Return on Investment?” [#AskBP 041]

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today on ESP podcast we're talking about the difference between cash-on-cash return and return on investment stay tuned you're listening to another bigger pockets ask BP podcast where you'll hear short direct answers to your biggest real estate questions submit your questions today on facebook twitter or the bigger pockets forms by using hashtag ask BP and don't forget to pick up your copy of the ultimate beginner's guide to real estate investing and other great content when you sign up for your free account at bigger pockets dot-com with that let's get to the show today's question comes from zach from denver and he's asking what is the difference between cash-on-cash return and return on investment and these are two critical metrics measured in percentages that real estate investors used to determine the return and stability of any real estate investment the cash-on-cash return is a measure of stability whereas return on investment is the measure of total wealth creation by any investment a I to kind of give you an example here let's say i purchased out $100,000 property that runs for a thousand dollars a month if the expenses are four hundred dollars a month then I'm cash flowing six hundred dollars per month over the course of a year that's 7200 dollars 7200 dollars is seven point two percent of $100,000 in that situation my cash on cash return is 7.2 % y is that number important well that means that if i had an expense that year let's see how to put on a new roof or redo the plumbing or the electrical or put in a new kitchen on that 70 $200 helps me cover that expense that that uh it's a measure of stability i could rent could drop I can have a vacancy but i'll still cash flow i won't have to take money out of my pocket to pay for the investment in that in that hundred-thousand-dollar property so that that that's what kind of the cash-on-cash return i really like cash-on-cash return when i'm looking at investments because that helps me decide hey this property is stable it means that i want to put my personal money into it afterwards and the property will pay for itself over the long term and i can let the other factors such as appreciation principal reduction on and tax benefits go to work for me over the long run without having to take money out of my own pocket now those other factors that i just talked about those are the measures of total return on investment so where's where's cash-on-cash return that 7200 dollars is simply the amount of money that is the amount of cash is being generated by the property other factors are play I that helped me build wealth real estate and these three those other factors are primarily appreciation on the property so if the property is a hundred thousand dollars and over the course of a year it goes from a hundred thousand value to a hundred and ten thousand dollars in value then I've made another $10,000 my wealth has increased by $10,000 that's not a cash position is not cash i can access right now it's not stable it depends on the market it depends on the condition of the property when i sell it and how well my real tour or myself cells that property but it is equity it is wealth that I've generated through uh owning that property over that period of time the next portion piece of golf building or the third piece of it number one is cash flow and number two is appreciation that third piece arm is going to be principal reduction so let's say I purchase a hundred-thousand-dollar property and i use a twenty-thousand-dollar down pant all of a loan for $80,000 my loan payment my mortgage and a principal and interest might be 450 of that 450 let's say a hundred and fifty of that goes to praying down paying down the principal on alone and the other your remaining amount goes towards a you know prince a mortgage interest and insurance and taxes so that a hundred fifty dollars over the course of a year is going to be about eighteen hundred dollars that's an additional one-point-eight percent return on my hundred-thousand-dollar uh property now because I'm we put down twenty thousand dollars that's about nine percent return that's that's true wealth building that's actually a very large return on a twenty-thousand-dollar payment and it's going towards my wealth and my the value that i have in that property again that's not going to be measured by cash-on-cash return I can't access that money until I sell the property and unless I sell it at a hundred-thousand-dollar price point but it's still value that I'm creating in with my real estate investment and the fourth way that you've got to build wealth real estate investing is through tax advantages and tax breaks so let's say that the property is depreciating on let's say let's say that I claim a three thousand dollars in depreciation on that property i'll reduce my tax bill by three-thousand-dollar reduce my adjustable gross income by three thousand dollars that will help me save maybe a thousand dollars on taxes again that thousand dollar savings and taxes is wealth creation for me it's not cash that I'm producing as a result of the investment but it is still a well that I get to retain and and harness and invest as an investor as a real estate investor in the next investment so the four ways you build wealth through real estate investing r1 through the cash-on-cash return which is the difference between rent and expenses on the property throughout the course of the year to through appreciation 3 through principal pay down if you assuming you have a mortgage and our financing your investment and for through tax benefits of those the only one that I that is safe that i can access immediately and on a monthly basis is that cash flow so I really care about that cash on cash return first and foremost in any investment because I know that that's going to determine the stability of the investment if I have to pour a $300 into the property every month and then my tenant moves out night don't get a thousand dollars per month in my investment I could be losing lots of money very quickly that makes my pride makes my investment very unstable if i do not have a high cash on cash return but the other factors are also at Play so again that cash on cash return is a measure of stability where's return-on-investment factors in cash on cash return and the other less obvious more subtle ways that you build wealth the real estate investing I hope that was helpful to everyone and i hope that you are now understand the difference between cash-on-cash return and return on investment before we go I will leave with my quote of the day which is one of my personal favorite quotes I've ever read Alice says would you tell me please which way i want to go from here that depends a great deal on where you want to get to pick at I don't much care where said Alice and it doesn't matter which way you go set the cat so long as i get somewhere I was added as an explanation oh you're sure to do that said the cat if only you walk long enough Lewis Carroll alice's adventures in wonderland i really love that quote I think it speaks a tremendous amount towards having a direction it's amazing how many people just kind of wander through life have you know i'm not sure what they want to get to and then you know are frustrated when they don't get you know where whether it was some other peers are it's a I definitely believe very strongly and having a direction that I'm heading and in focusing on where I want to get to and I think that all my decisions become obvious and all of my choices become clear when when you have a goal and we have a direction you're heading if not doesn't really matter what you do what you invest in because you'll end up somewhere finally let's let's get out of here and remember in pursuing your goals don't just learn but take action for the spp podcast this is scott trench signing out you've just heard another episode of the bigger pockets ask BP podcast submit your questions today on facebook twitter or the bigger pockets form by using hashtag ask BP and for more incredible real estate investing tools and education including a free download of our book the ultimate beginner's guide to real estate investing head over to bigger pockets dot-com and sign up for your free account today we'll see you on the next show today on the bass with it

 

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On today’s episode of the #AskBP podcast, learn the difference between cash on cash return and return on investment, pertaining to real estate investments. You’ll also learn the four wealth generators of real estate, and how combining all four can give you incredible results. This is the first episode recorded by Scott, and we know you are going to love it! Stay tuned!

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Real Estate · Investing · Videos

Comments to What is the Difference Between “Cash on Cash Return” and “Return on Investment?” [#AskBP 041]

  • This is a great video!

    Fasted Sith June 15, 2015 5:25 am Reply
  • Great explanation Scott. Thank you.

    You forgot to spike your hair up in the front – hahaha 🙂

    BJ Anderson June 15, 2015 11:55 am Reply
  • Thanks @biggerpockets and @scotttrench!
    really great content.
    clear and concise.!

    Hugues Armand-Delille January 16, 2017 7:15 am Reply

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