The FortuneBuilders Real Estate Investing Show is back again this week hosted by a familiar face in the community, our very own Passive Income Director Paul Shively! He’ll tackle one of the most important topics in real estate investing – how to analyze YOUR next real estate deal.
When it comes to making a real estate investment, accurately analyzing the potential of a deal is crucial in predicting its success. For the new investor, however, the calculations and terminology can be confusing, to say the least. In this episode, Paul will explain the four metrics you should know when analyzing a real estate deal in simple terms so that you can invest with confidence.
Listen to the Podcast Here:
How to Analyze Your Next Real Estate Deal
Welcome, everyone. Welcome back to the FortuneBuilders Real Estate Investing Show. I’m your host today Paul Shively. I’m one of the owners of Equity Street Capital along with Than and Paul, which is our commercial real estate investment company, as well as the director of the Passive Income Club, which is a company inside of FortuneBuilders that helps investors build their portfolio of single family homes. I’m honored to be the host of today’s podcast.
What we’re going to be talking about is how to analyze your next real estate investments, right? Where do you get started? What do you look at all those interesting things that you should know, before you make your next investment? And I’m really, really excited because we’re going to be bringing that type of topic, that type of education to this podcast moving forward. Than and Paul have actually asked me to be one of the regular hosts of the podcast, which is something I’m super excited about. Because for me, it’s not just about the transactions. For me, I love the education part, I love helping and actually have helped over 6000 families through the various companies that we own with Than and Paul. We’ve helped over 6000 individual investors start their journey and start investing. And that’s what I’m so excited to do a little bit of today with you in this podcast, as well as moving forward, bring those types of topics to this show.
Word of the Week
So today, the term of the week is investment objective. And what we’re going to be doing is helping you understand, number one, what is an investment objective, but number two, how important it is, right? And how you should be diving into this and understanding what your investment objective is as part of your investment analysis. Moving forward, super excited to do today’s education. So let’s get into it.
Cash on Cash Return
So when you’re investing, the first thing you need to look at is understanding what those return metrics are. Return metric number one, often that we use is called cash on cash return. What this means very simply, it uses some basic math. What this means is, say I invest $100,000, just for round numbers. What a cash-on-cash return will show me is my cash into the deal. In this hypothetical example, $100,000. What is the cash coming back out? That’s what the cash on cash return means cash in cash out, right?
And what is usually measured on a yearly basis? So cash on cash return is usually one year, right? Versus your individual investment versus what you get back out? Simple math hypothetical situation put in $100,000. I get $20,000 back in year one. What’s that return? That’s about a 20% return in that particular scenario, on my investment in the cash on cash returns $20,000. In that case, what does this return metric tell us? Why is it important? Why do we use it?
Let’s go by layman’s terms.
“I didn’t get good at math until it started making me money.”
Okay, let’s be very, very blunt with each other. What this math tells us really simply is if you are an investo who’s looking for a return on your money now monthly, quarterly, yearly, whatever it may be. Cash and cash return should be something you should focus on. Very, very intently. What it does is it says okay, how hard is my money working for me in the here and now? When people talk about a current return, what they’re talking about is cash on cash return, what current return means is, okay, I put money in what do I get back? Maybe not right away, maybe it takes two or three months. But, you know, as soon as I put money in what’s coming back to me, and what’s that percentage, versus what I put into it? Again, hypothetical example, I put in $100,000. I get $20,000 a year back out and monthly cash flow or quarterly cash flow. That’s your cash on cash return.
Average Cash on Cash Return
The second metric, remember, there are four main ones I want you to learn. The second one is average cash on cash return. So what’s the difference? Well, we just talked about cash and cash, what is the average cash on cash? Do you own most investments? Long Term Investments, single-family rentals, commercial buildings, whether it’s retail or office or multifamily buildings, maybe you’re looking at a four-family unit and trying to compare it against a single family. Right?
Are you going to own it for one year or multiple years? Well, most of the time, and what we teach people is your active deals, you’re flipping and getting into and out of the year, your long-term deals, you really want to own for 5, 10 or 15 years. Most of the deals I buy for the long term I want to give to my kids one day, right? I really only invest in stuff and put my long-term money in the stuff that I am willing to own until I give it to my kids and send them to college off of it. So cash on cash return, which remember, is just a one-year metric. What about the other? Four years? 10 years? 20 years? We’re gonna own it, right?
Average cash on cash is a really important metric. What it does, is it’ll tell us the same thing that our year one cash on cash will tell us, but it tells it for the lifetime of the deal. Wwe have to have some kind of projections. So let’s project we’re going to own it for five years or 10 years. Now, along that lifetime, there’s gonna be things that happen. Prime example, we may plan to do a refinance, maybe in year three, or year four.
So in this particular example, what a refinance is hey, I’ve owned this thing, I’ve owned the single family home, or I’ve owned this commercial building, or building this office building for four or five years, right? And maybe it’s gone up in value. And I have some debt on it. Well, I have some equity built it will let me go to the bank and take some of that equity back out in the bank. So yeah, sure, no problem. Here’s a new loan, we’re able to give you some of your equity back. It is a phenomenal thing as an investor.
What that does is it lowers what our basis. I no longer have that $100,000 In the deal still. If I’m able to get half of that back, well, my cash and cash return changes, right? Because my money in the deal now was only $50,000 at that point. So maybe I’m three or four years in. I said wow, built up a lot of equity. Let me get a loan to take some of that equity back out. It’s called a refinance. Now my basis is lower. I no longer have 100 And I only have $50,000 in the deal, well, my cash and cash return is going to change because the income I’m earning should really only be calculated onto the money I still have left in the deal. So my cash and cash return changes after I refinance. So what average cash on cash will do is it will show you your one year two year three until you project to end the investment, it’s five years or 10 years down the road, we’ll show you the average of all those years of cash on cash return.
Equity Multiple
The third metric is what’s called equity multiple. Okay, what is equity multiple? Let’s go back to our hypothetical example. We put in $100,000 on investment. After that investment is all said and done and it’s sold. we project out, Hey, I’m gonna own this for five years, I’m gonna own this for 10 years, whatever it may be. After it’s all said and done. What did your $100,000 turn into? You take all the cash flow, all the proceeds from the future sale? And you say, okay, my $100,000 is gonna turn into 150. So that would be a 1.5 times equity multiple, you put in 100 and you’re projecting that you may get out 150. That’d be a 1.5. multiple. So why is this one important? What is this one telling us?
This one’s really important for the investor who may not be on a different timeline, or may have a different objective. The investment objective is so important because you’ll know which one of these matters to you. Equity multiple really matters to an individual who’s looking to grow that hypothetical $100,000 investment over time. Don’t get hung up on the $100,000 investment you don’t eat there are a lot of ways in real estate you can invest $5,000 $10,000 $15,000. There are ways you can invest with no money to get started. I’m just using hypothetical examples. So don’t get hung up there okay?
Equity multiple shows the growth of your investment over time. So an investor who has a longer-term timeline may be younger or may have cash flow figured out, they may have a great job, they may not want to leave their job, they may have a ton of income coming in from other investments right? They may have a pension or something. My wife works for a state-run University here in California so she has a great pension plan set up for her which is awesome. So for her, because we know that’s coming we can make different investment decisions where equity multiple and say hey, I’m going to put in x amount of dollars, if that grows to 150 or 200, over a certain time horizon, well, that may fit in investment objective more uniquely. That gloves gonna fit that hand a little bit better for that investor who has that goal, that investment objective versus a cash flow goal.
IRR
The fourth metric is, again, IRR or internal rate of return. What it does in very simple layman’s terms, IRR basically takes equity multiple, and cash on cash and mashes them together. When the internal rate of return really measures one level deeper, let’s scratch the layers back one level deeper. Remember how we talked about we’re going to own this for 5, 10 or 15 years? Probably at some point have what’s called a capital event. All that really means is, we may sell a piece of that overall property. If it’s a single-family property, we may do a refinance.
We only have one piece of property in a single family, we can’t sell part of it, but we may refinance part of it, as we talked about, and pull some of our equity out. That’s a capital event, like we talked about earlier lowers the amount of money I have in that deal, right? Maybe you own an office building, and you’re going to maybe someone wants to come in and you know, buy a part of it, or you own a retail building or shopping center, and you sell that piece of it out in front that has a quick service restaurant, like think of McDonald’s out in front, and you will sell that piece and still on the back. We do a lot of that, right? That is what’s called a capital event. What happens with that is we’re able to lower instead of $100,000. And we sell a piece of it, we get a little bit of back, which is nice. IRR measures all the dollars you have in the deal for as long as they’re in the deal. What are they making for you? How hard are they working? What’s that percentage they’re working at for you? That’s what IRR shows.
Summary
Again, I’m excited to be on this podcast and the show with you on a regular basis now, to give you kind of that long-term investment type of viewpoint. How do we analyze long-term deals? How do we analyze your next investment deal? What’s the difference between commercial and single family? And how do we decode this long-term investment world for cash flow for wealth generation to help you build a portfolio of real estate that does whatever it is you want to do?
That’s my whole world. That’s what we do. In my world here at FortuneBuilders. I’m so excited to bring that to you on a regular basis. Honored to be one of the hosts here at FortuneBuilders Real Estate Investing Show moving forward. I’m gonna sign off like this. Just like we always do. Take care of yourself. And in today’s world, if you can try to take care of at least one other person alongside you. Take care.
