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Cap Rate vs Cash on Cash

[fa icon="clock-o"] Mar 15, 2018 10:00:00 AM [fa icon="user"] Brent Maxwell [fa icon="folder-open'] investing, real estate, real estate investment, cap rate

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If you’re going to invest in Detroit real estate, you’ve got to know the terminology that comes with it.

Cash on cash is the return on investment of the money you’ve put into play in an investment. It’s cash back on the cash you’ve invested.

If you invest $100,000 and you make $10,000, your cash on cash is $10,000.

Cap rate is the return of the property on the purchase price of the property. The net operating income, which is the gross rents received, actual income, minus actual expenses, is your net operating income for the year.

It’s a lot of numbers, I know, but stay with me. You’ve got to know whether it’s worth your time and resources to invest in Detroit real estate!

Your net operating income divided by the purchase price of the property is the cap rate of the property, which is short for capitalization rate.

If you have $15,000 in rental income on a property, and $5,000 of expenses, your net operating income is $10,000. If you spent $100,000 to purchase the property, your cap rate is 10%

Got it?

Where these numbers stray and spread about is any property that is financed and has debt service. Debt service comes after net operating income.

If you have a loan where you’re paying 5% on $80,000 borrowed, you’re paying $4,000 a year, so your cap rate doesn’t change, but your cash on cash does. Like this: you have $6,000, and you invested $20,000, which means your return, cash on cash return, is $6,000 on $20,000, so it’s 30%.

It’s important to understand the financials of any deal you make, to get the clearest picture of its value. Just ask us – we can help break it down and make the numbers make sense for you.

Brent Maxwell

Written by Brent Maxwell

Brent Maxwell is the founding partner of IPS Realty

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