Cash on Cash Return (CoCR) – Don’t Get Blinkered By This Newbie Mistake

Chi Mei @GoodPlace

For those who emailed me questions (and data requests) to pass on to Penrose related to his articles on property investment metrics and Cash-on-Cash Return – he has been away, and will reply to the emails personally when he gets back. However, I do notice that there are some misconceptions particularly about CoCR which I am going to address myself since Penrose is away.

Email from GoodPlace Digest subscriber Yuen Hsia (reproduced here with her permission) –

kathy-yuen

Now as far as I know (he can confirm this when he gets back), Penrose uses COCR as his first filter to eliminate “dud” opportunities that come to him – NOT as a way to choose properties to eventually invest in. Therefore, it’s a mistake to simply line up properties in terms of COCR and then pick the winner. As such, the property with the highest COCR may NOT be the best investment choice because of a few reasons that I am going to cover in today’s article.

Why Do You Invest?

Whenever newbies email me to ask about newbie questions (nothing wrong with that – just wanna point that out), I usually get them do a little homework – I make them do this thing called the GoodPlace Property Workout (see this). You see, too many people are buying properties because of all the wrong reasons, and by completing the workout, they should be 100% clear about WHY they want to buy property in the first place.

In general, there are two “styles” of investing:-

  • Type #1: The “I Wanna Quit My Job” kind.
  • Type #2: The “I Wanna Get Rich” kind.

Of course, there are those who are hybrids of both (i.e “I wanna quit my job tomorrow and get rich by next week!”) but it’s important to identify with one of these two as far as your investing style is concerned because the two are remarkably different especially in terms of the types of properties that you choose to invest in.

For example, you can never get rich (in the traditional sense) by buying and renting out a shoplot in Kajang to a Mamak eatery for RM950 a month. Conversely, flipping properties to earn enough to quit a job is a fool’s endeavour in this day and age (show me someone who has claimed to do that and I’ll show you a despicable Guru who’s out to scam you).

Now tying this back to the original question, whether you should use CoCR as your de facto investment criterion depends on which type of investor you are. Penrose, as I know him, is a cashflow investor (i.e. Type #1), and as such, he pretty much swears by CoCR.

Yuen Hsia had wanted to compare the CoCR of three properties (Indera Subang, Arcadia and Riverdale – all in USJ) and pick the top out of the three. This could be a mistake because she has not taken account into one particularly important consideration which is not covered by CoCR – I’ll talk about this next.

The Problem With CoCR

Because CoCR is a present, “as-is” cashflow measure, it overlooks a crucial aspect of property investment: appreciation. CoCR “purists” will argue that as property prices appreciate, the rentals will also go up, but here’s the counter argument: there is no empirical evidence (at least in Malaysia property) that rental yield is correlated to appreciation. It is therefore best to treat CoCR (at least in the Malaysia context) as a pure cashflow metric.

So is CoCR useless for an investor looking primarily for long-term price appreciation?

In a way, yes. But then again, such investor is rare (like an Arab prince wanting to park his monies in the form of KLCC condos), and probably not you. Like every other investor, you’ll probably want a good mix of cash and long-term yield, which means that CoCR can be useful to you when you make your decisions.

Like Penrose, I use CoCR to FILTER out properties, and not as the criteria to DECIDE on which property to invest in. This will also be my recommendation to Yuen Hsia – she should calculate the CoCR for all three properties, and if they all pass the threshold (this has been covered by Penrose in his two articles), she should then move on to metrics like Internal Rate of Return (IRR) – these will be covered in another one of Penrose’s articles in the future.

And while you’re waiting for the next installment of our geek-worthy guides on property math, here’s an awesome Harvard Business Review article on ROI calculation mistakes –

The Most Common Mistake People Make In Calculating ROI

The Bottom Line…

To summarize, here’s a good rule of thumb to follow.

If you’re a Type #1 investor, you’ll primarily want a property with good CoCR, with long-term upside a bonus. You should go for particularly mature areas with little to no new launches which mean that incoming supply is limited.

If you’re a Type #2 investor, you’ll completely toss CoCR out of the window, and go for properties in “hot” areas. Be careful as this requires you to have a long “staying power” and be fine with your properties being vacant while you wait for the prices to go up.

I hate to sound like a flippant Guru, but it’s true: there’s no right or wrong answers, and it all depends on what your goal is: to merely generate enough cash for you to stick it to the man and quit the rat race, or to get stinking rich so that you get to donate your filthy lucre to some third world country leader when you grow up.

About Khai Yin

When I am not writing for GoodPlace.my and helping my readers find properties though the DealMatcher service, I spend time doting on my three kids: Wenyi, Qinyi and Eian. My personal stuff, some published essays and contact details can be found at khaiyin.com

Comments

  1. I think that cash on cash return is best suited to investors with a portfolio of investments and a target rate for this particular investment opportunity. Cash on cash best approximates the return from securities. It gives you a broad idea of the return from the cash you invest.

    I suppose this stuff is complicated, but it never causes me anything but amazement that investors think that there’s some magic formula that – if applied rigorously – will ensure success. This is complicated forecasting with limited knowledge about the unknowable future. Good tools get you down the road a pace, but thinking they will solve all problems is naive.

    • @nokomis – True, dat!

      I wouldn’t call CoCR “forecasting” though – you use actual, present-day numbers and extrapolate for the first year, which should be fairly accurate.

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