Cash on Cash Return when deals involve bridging
Posted by markharrison on April 29, 2008
I got an email yesterday from a reader of my book. In the email, he asked a question about how I take bridging fees into account when calculating CCR.
Alas, the answer is: “It depends.”
Quick definition of terms: A bridging fee is what you pay to a lender for a (very) short term loan, in today’s market – typically an hour or so. The most common reason for doing this in today’s market is that some lenders will lend MORE on a property if you already own it and re-mortgage it, than they would if you were just buying it. Hence, some people buy on a bridging loan, then re-mortgage an hour later.
The motivation behind this is, of course, that it allows the investor to get more cash straight back out – so that rather than having to commit £20-30k as a deposit, they can in some cases borrow the full amount… as you might imagine – not a strategy without risks!
CCR, or Cash on Cash Return, is a way of looking at an investment in cash terms. It’s the annual cashflow divided by the up-front cash costs.
Example: If you have to put £20,000 down as a deposit / fees in buying a property, and get a positive cashflow or £100 per month after all costs, then your cash on cash return is £1,200 / £20,000 = 6%. (The £1,200 is, of course, 12 months at £100.)
So, to the original question – how do I treat bridging costs when calculating CCR.
There are three ways of working this out, depending on how sophisticated you are, and how conservative you want to be.
The simplest way is to tread the cost of the bridging fee to the rest of the cash you’re putting in up front. This, of course, is what you have to do if your re-mortgage does not cover those fees. This is also the most conservative way to look at things (and in today’s market is not one in which to take high risks, in my opinion!)
The next easiest way is to work on the basis that your remortgage would cover them (assuming, of course, that it does!). This will add to the monthly mortgage fee, so reduce the income… and the CCR will go down as a result.
The more sophisticated way is to treat the bridging fees as a finance fee tied up with a particular mortgage. As I wrote back in 2006 for YourPropertyExpert.com, in an article called The Impact of Fees, I have “strong views” on how to treat such costs:
I treat mortgage arrangement fees (including bridging fees) as if they were fixed-term loans that had to be repaid over the period of the fixed/discounted mortgage deal. So, if you are paying £500 in mortgage fees, plus £1,500 in bridging fees, and signing up to a 2-year fixed rate mortgage at 6% (interest calculated annually in advance), then you have to assume a cashflow hit of £91.13 each month.
If you had not had the £1,500 in bridging fees, then the cashflow hit of the mortgage fees would have been one-quarter of that – about £22.78 each month… so the effect solely attributable to the bridging fees is
You can see, then that bridging, if costed conservatively, has a big impact on monthly cashflow – that’s only one of the reasons why it’s an “advanced” technique, only to be used by those with both good financial education and a strong stomach for risk.