I have $600k in capitol to invest.
If I buy at a fair price and assume 3 pt spread between int rate in loan and cap rate how much cash flow could I return?
Note this is not about maximizing my total return in investment it’s about maximizing cash flow.
I look at this in 3 scenarios:
Buy $600k park cash
Buy a $1.8 million park with a loan at 30% down
Some mix in between like 1.2 m with 50% down.
Any thoughts?
Buy the biggest park that makes sense… year 1 we “typically” look for a cash return of 10-15% (not including loan pay down) so in theory you’re getting $60-90k back. That said, we also bought a park last year that was close to a 100% cash return and we’ve bought others that have been negative the first year.
Consider the tax advantages of a more expensive asset. Your cashflow will increase by simply following legal tax deductions and depreciation. Financing a larger asset is easier with more attractive lending options and terms available.
As long as there is a spread between the loan rate and the cap rate, go with maximum leverage.
Here’s why.
Assume a 10% Cap Rate Park and a 7% loan amount. Pretend it’s a $1,000,000 park.
$1,000,000 10% cap if you pay all Cash, you get $100,000 per year in FREE Cashflow. Or a 10% cash on Cash Return.
If you leverage, You put down $300K. The loan amount is $700K at a 7% interest rate monthly PMT is $4600.
$4600 x 12 = $55,200 annual loan payment. $100K NOI - $55200 Loan pmts = Free Cashflow of $44,500
$44,500/$300,000= 14.8% cash on Cash return. Plus you get the principle paydown, which I know you don’t want to count, but it’s still a nice benefit.
The higher the differential between the Cap rate and the loan rate the better off you will be.
The issue we are currently facing, is cap rates are not increasing as fast as loan rates. Sellers are not willing to come down in price in lockstep with the rise in interest rates (August 2022). So there is an issue with leverage, loan amount, and DSCR. As the Cap rates and Loan rates get closer and closer, a higher downpayment is required. In my local market interest rates have gone up to about 4.5-5.25% and cap rates have stayed low at 5% or lower. So down payments in my market are having to go up to meet DSCR requirements.