Investing is about numbers, and when measuring return on investment (ROI), most of us focus on the math. However, not all math was created equal – some things are less apparent than other. Allow me to illustrate:
I purchased a 10-unit apartment building in February of 2013. Without getting into too many specifics, let me just say that the purchase price was $373,500. I was able to put together a financing package for this acquisition which covered 95% of the purchase price, leaving me with the requirement for a cash down-payment in the amount of 5% of the purchase price. However, after all of the prorations, my cash contribution to this deal ended up being around $5,300.
This was huge! Furthermore, even having financed virtually all of the purchase price, the building was showing $1,000/month of cash flow with a number of clear options to grow that to at least $1,700/month.
I’ve began this process.
In one instance, I remodeled a unit at a cost of $6,000 which enabled me to raise the rent from $575/month to $685/month. In addition, I was able to pass the expense of the water bill onto the tenant, which returned about $15/month to the NOI. Cumulatively, I was able to create additional NOI of $125/month in this case, and since there are no on-going expenses associated with this increase, all of it flows through o cash flow.
Thus, I spent $6,000 to generate $125/month of cash flow, and the simple question I will attempt to answer in this article is – Was it worth it?
The Obvious
On the surface, what I’ve done may not particularly impress. While he sheer fact the cash flow improved by $125/month is naturally a good thing, the achieved Cash on Cash is a measly 25%:
COC = $125×12 / $6,000 = 25%
Typically, I wouldn’t even get out of bed for that little of a return, so to speak. However, let’s dig a little deeper…
Valuation
My main objective in most long-term holds is Stable Passive Cash Flow. I see this as my ticket to financial security today, and financial freedom tomorrow. Having said this, the reason I prefer to operate in the multi-unit space is because any increase of income has the fortunate consequence of growing the value of the investment due to the fact that the value in multi-family space is a function of income. In other words, the more income, more specifically the NOI, the building represents, the more the value of this building to an investor.
In this case, therefore, the expanded annual NOI of $1,500 ($125/mo. x 12) constitutes an increase in value of $15,000 at a 10% capitalization rate, which in my neck of the woods happens to be the going CAP Rate for a building such as this. Thus, I invested $6,000 to realize equity of $15,000 which is a 250% ROI -I think that’s a pretty good use of 6k, but this gets better!
The apartment in question was in rough shape and definitely needed a facelift to appeal to a discerning tenant. However, I was already able to turn to another apartment in this building, which was in much better condition and in need of only a $400 clean-up. Guess what – this second unit went for a $60/month increase, and all it cost me was $400. Can you figure out the ROI on that?
Sure, I may need to season the building for 2 or 3 years in order to realize the benefit of this, but if I can do half as well with the remaining 9 units, I should be able to increase the value of my building in the range of $100,000. Now, conceiving of what I’ve done in this way certainly paints my decision in a different light – wouldn’t you agree?
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