For more than 40 years, RealData has helped real estate investors and developers navigate the road to success.
Our mission is twofold: To supply the software tools you need to evaluate commercial, residential and mixed-use income-property investments, projects and partnerships; and to provide you with the educational materials and resources to be a knowledgeable investor.
I had a question recently about a metric called Yield on Cost, aka Return on Cost and also sometimes called Development Yield. So what is it and when and how might it be useful?
I remembered a day when I was an undergrad psych major at Yale (a day in 1964, if you can believe) when my professor did an experiment in class that stayed with me for all these years.
He had a little mouse and what looked like a Skinner Box – you might remember those from your college years, an enclosure designed to use positive reinforcement – receiving food pellets in a tray – to teach the mouse to perform some action, like pressing a lever.
The prof came into our lecture hall in front of a hundred or more bright-eyed freshman carrying a modified version of the box: It had two separate levers that would each deliver food pellets, and one of the levers was designed to pay off much more frequently than the other.
Users of our Real Estate Investment Analysis program sometimes call us with questions that are not about the software but about the underlying analysis. If we had a “greatest hits” list for those questions the all-time winner would be this: “My cash flow goes up each year; the value of the property goes up each year; but when I look at the Internal Rate of Return, it goes down almost every year. What’s up with that?” To see how this can happen, let’s take a look at two very simple examples.
Regression – no, it’s not what your family and friends accuse you of when you want to trade in the mini-van for a two-seater stick-shift convertible (well, maybe it is, but that’s a topic for a different article). If you’re familiar with our RealData software, my online video courses, and my other blog posts here, then you know that I’m usually talking about income-producing property like multi-family, retail, office, or the like — seldom about single-family homes. And when we estimate the value of most income properties, we typically do so by looking at their income stream.
The rise of home-sharing platforms like Airbnb has been a boon to property owners, especially owners of smaller income properties, but it has also prompted municipalities to introduce regulations on short-term rentals (STRs). Many places impose restrictions, such as requiring permits or licensing, limiting occupancy, and restricting the number of days permitted.
We usually think of Return on Equity (ROE) as a straightforward investment measure. That’s understandable, because the traditional method of calculating ROE is pretty clear cut: Take your cash flow after taxes and divide it by your initial cash investment.
Inflation, interest rates, concerns about recession, pandemic-inspired work-style changes, taxes. There are enough wild cards in the deck to give any economic forecaster vertigo.
Not all real estate markets or all sectors are created equal, so to paraphrase an old TV auto ad, your mileage may vary. Nonetheless, we think it’s possible to make at least some reasonable and general forecasts about the near-term prospects for commercial real estate. Here is some of what we’re hearing, and thinking.
One topic that often gets less attention than it deserves from real estate investors, however, is resale. Some tend be dismissive, looking at resale as speculation, but many others simply find it difficult to focus seriously on the matter of selling a property they haven’t yet purchased.It may take a little extra discipline to work a consideration of resale into your investment mindset, but it is just such discipline that often separates the successful investor from the sorry.
Life is too complicated; we have too many choices, too many options, too many channels on cable TV. It’s not surprising that sometimes we crave simple answers to complex questions.
In the first part of our discussion, you looked at the simple math that underlies Cash-on-Cash Return. The short version goes like this: First you calculate your property’s first-year cash flow before taxes—essentially all the cash that comes in from operating the property minus all the cash that goes out. Then you divide that by your initial cash investment, and that percentage is your Cash-on-Cash Return. Nothing could be simpler.
Not all partnerships include a preferred return but, in those that do, its purpose is to counterbalance the risk associated with investing capital in the deal. Typically, the investor is promised that he or she will get first crack at the partnership’s profit and receive at least a X% return, to the extent that the partnership generates enough cash to pay it. In most partnership structures, the cash flow is allocated first to return the invested capital to all partners. The preferred return is paid next, before the General Partner or Managing Member receives any profit.
A while back, I posted a two-part series called “The Cash-on-Cash Conundrum.” In the first installment I explained the calculation and underlying logic of CoC, and in the second I discussed some of the pitfalls of overreliance on this particular measure.