CASH FLOw in Denver?
Denver is an appreciation market. This is not dissimilar to other expensive markets. But can you really cash flow in Denver? That’s a loaded question. Like much of real estate, how creative can you get and how hard are you willing to work for it? As most investors know, cash flow is simply the delta between gross rental income and monthly expenses (or you can look at it annually). You can apply the 1% rule (meaning the gross rents you can command on a property is 1% of the purchase price) as a first blush estimation of potential cash flow. For instance, if you buy a property for $400,000, can you command $4,000 in monthly rent? How about an example in the Denver market where the average single-family home price is $700,000? Will that rental command $7,000 in rent? Likely not. So how can you cash flow in an expense market like Denver? Here are just a few ideas of many:
Purchase a single-family home and rent out by room. If you can purchase a single-family home with 5 bedrooms for $600,000, and you can charge $1,250 per room = $6,250/month.
Purchase a single-family home for $550,000 that can be easily converted into two units. Furnish both units, make them stand out from the competition, and rent to travel nurses, insurance companies, or other corporate housing companies. Rent each unit for $2800/month = $5,600/month.
Purchase a 8-unit in a suburb of Denver for $1.2M. Each 2BR unit commands $1850/month = $14,800/month
Just remember that the 1% rule is only a benchmark, and it’s often hard to find a “1% property” using traditional long-term rental strategies. Full under-writing is necessary to determine the full breadth of income, debt liabilities, and owner expenses. With any of these hypothetical scenarios, you should consider your 1) cash-on-cash return, 2) your long-term IRR, and 3) other investment-related benefits.
Cash-on-cash return is the amount of return based on your annual cash flow and the upfront capital required to make the purchase and stabilize the purchase. For example if your investment annual cash flow is $10,000, but it required $200,000 in capital to make the purchase (down payment + improvements + (furnishings)), then your cash-on-cash return is 5%.
IRR is your Internal Rate of Return. This is the calculation that comes from your pro forma and the performance of the property over a set time frame - 5, 10, 15 years. This calculates all of the cash flow over time + profits from sale after fees and loan payback. In an appreciation market, this is where you hope to see much of your return over time. Your IRR goal might be 15%-20%, but your cash-on-cash return might be 5% over time.
Don’t forget to factor in the amount of debt paydown over your hold period. The tenants will be paying down your debt, which can be quantified and added to your ROI. Also, depreciation expense will be take each year on the property, which should also be considered in your overall ROI. So even if your investment in an expensive market only cash flows 5%, you will reap the benefits of appreciation, debt paydown, and depreciation.
If you’d like more information on how to calculate cash-on-cash return or pro forma analysis (aka underwriting), contact me via the form below. I help my clients develop sound pro formas that inform good investment decisions.
