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How to Do Due Diligence and Calculate Cash-on-Cash Return on Investment?

How to Do Due Diligence and Calculate Cash-on-Cash Return on Investment?

We must master both and having as part of our strategy for Real Estate Investments.

Master Investor
April 23, 2024

Summary:

Finding an investment's cash-on-cash return doesn't have to be tough.
Don't base our investing decisions solely on financial models.
Performing thorough research is essential for profitable investing.

Many individuals believe that investing in real estate is risky and challenging. Of fact, there are entire industries that profit off the complication of seemingly basic subjects. We at masterinvestor have learned from the master himself to keep things as straightforward as possible.

We have a straightforward recipe for success in real estate.

Two important question to ask when investing in Real Estate:

What is this real estate investment’s cash-on-cash return?
Have we investigated a real estate property thoroughly?

These were the two sides of the coin that, in our opinion, were necessary to proceed with any business.

The majority of individuals concentrate on cash-on-cash return; yet, financial models are merely snapshots of current knowledge.

If we do not conduct due diligence and an investment property's cash flow yields a strong return on our capital invested, we run the danger of discovering a hidden expense that will demolish our real-world financial models.

We don't have the whole story as an investor. To get the whole picture and make any required adjustments to our financial assumptions, we must do our due diligence.

How to figure out the real estate cash-on-cash return with ease?

First things first: we should never purchase an investment property if it doesn't generate cash flow or offer a profit on our investment. Although it may seem apparent, some investors use complex formulas like these to purchase investment real estate:

Rate of Return Internally:

This is a return on investment calculated under the assumption that all passive or cash flow income is reinvested right away, giving us a return on our initial investment plus interest.

Present Value at Net:

An projected discounted rate for the future value of money is taken into consideration here.

It computes a discounted rate of return by comparing the current investment value to the future cash flow value.

Every formula has advantages and disadvantages, and none is as simple as cash-on-cash return. They rely on guesses, and depending on how well the study is done, those assumptions can produce quite different valuations. According to an old proverb, "Garbage in, garbage out."

Even if these factors are crucial for a successful investment, the most crucial factor is just knowing that our initial investment will yield a profit through cash flow. The simplicity of calculating cash-on-cash return is its strongest feature.

To calculate cash-on-cash return, divide down payment by positive net cash flow.

Here is an illustration using a few sample numbers.

Assume we spend $500,000 on an apartment building. We obtain a mortgage for the remaining $400,000 after making a $100,000 down payment.

Following the payment of all bills, our monthly cash flow is $2,000.

If we were to divide $100,000 by $24,000 ($2,000 x 12 months), our cash-on-cash return would be 24%.

A 24% return could be advantageous or disadvantageous, depending on our circumstances. That's up to us and our investors to decide. However, knowing our expected rate of return is a straightforward method to determine whether or not to proceed fast.

The value of doing our research before buying a property

After deciding whether a real estate investment offers a sufficient cash-on-cash return, we must use due diligence to ensure we receive the value for our money.

Investigating every nook and corner of a possible investment is known as due diligence. This is an action that requires "rolling up our sleeves." Any purchase agreement should include a condition requiring the seller to supply all required materials and access within a specific timeframe, as well as a due diligence period. This entails reviewing the financials, conducting inspections, evaluating the rent roll, and more.

Among the most crucial terms in the field of financial literacy are "due diligence." A knowledgeable investor learns the other side of the story during the due diligence process, which entails carefully examining a possible investment to verify all relevant information. We frequently find hidden costs during a due diligence stage, which means we have to modify our financial models to account for cash-on-cash return. This implies that in order to make our models function, we might return to the vendor and renegotiate the purchase price. If we ignore it, the transaction could soon turn from a profitable one to a terrible one.

When we ask any investor how they identify profitable ventures, the answer is virtually universally that they understand the importance of the due diligence process.

The faster we can complete our due diligence on an investment, the more likely it is that we will find the safest investments with the highest potential for positive cash flow and capital gains income whichever income the asset will generate.

Always use the Cash-Flow Triangle to ensure we are building or acquiring a sound investment operation.

A masterinvestor’s Thorough Research Real Estate Checklist

We always go through this checklist. Even our mentors of course make use of this list too. It is extremely comprehensive and has things (like "Phase I Environmental Audit") that were not around a long time ago.

As we go through this list, find experts in any areas we have concerns about, and bring them in to assess the deal together with reputable lawyers and accountants that ethics.

Rent roster current as of the paid-to dates
Enumeration of security deposits
Details of mortgage payments
List of personal possessions
Plans for floors
Policy of insurance, agent
Upkeep and service contract
Information about tenants: leases, applications, ledger cards, and smoke detector forms
List of suppliers and utilities providers, together with account numbers
An explanation of the structural changes made to the property
Engineering documentation and surveys
Commission contracts
Listing or rental contracts
Agreements for easements
Development plans comprise as-built architectural, structural, mechanical, electrical, and civil drawings, as well as plans and specifications.
Government authorizations or zoning regulations influencing the property's growth
Contracts for management
Property tax statements and tax bills
Bills for utilities
Journals of cash receipts and disbursements related to the property
Records of capital expenditure disbursements for the last five years that are related to the property
Statements of income and expenses related to the property for the two years before the deadline for submission
The property's financial records and state and federal tax returns
A generally adequate termite examination in terms of both form and substance for the customer
Any other records and papers that the seller has or is in charge of and that are essential to the ownership, use, or upkeep of the property
Market research or local studios
Building budget or actuals
Surveys or tenant profiles
Files for work orders
Two years' worth of bank statements displaying the property's operating account
Occupancy certificate
Abstract Title
Copies of all remaining warranties and guarantees
Environmental Audit Phase I (if applicable).

If we are buying an apartment building, make sure to physically walk around and inspect the property, including each unit, in addition to making sure everything on this list is secure. Make a note of all the damages, then utilize that list to bargain for a reasonable amount.

Ultimately, the secret to real estate success is simple: due research plus cash-on-cash return. If we do those correctly, we will be in excellent financial health.

The wealthy class on the planet do not work for earned income.

What is our investing plan, we must find out quickly.

"They question is, “How can we acquire assets without my own money?"

By investing in our financial education to master the job number one a wealthy entrepreneur which is to raise capital from direct sales (front end of the business or investment operation) and raise capital from the back end (from private lenders, banks, investors, family, friends, and other ways) of the business because it is one with instrinsic value and business integrity.

The wealth entrepreneur and inside investor creates something out of nothing

A business and investment shall build to raise capital from the front end through direct sales via systems. That is call marketing. The phrase that it takes more to make money is not true. Because there are many people with money "in saving accounts” in the bank but they are not making that money make more money. What it takes is financial education in order to master the ability to raise capital from thin air.

Understanding the 90/10 Wealth Revelation

Ninety percent of the world's wealth is held by ten percent of its inhabitants. the only way to the be part of the 10% is by becoming a business owner and an inside investor who thrives on the right of the Cash-Flow Circle.