A cash-on-cash return is a rate of return often used in real estate transactions that calculates the cash income earned on the cash invested in a property. Put simply, cash-on-cash return measures the annual return the investor made on the property in relation to the amount of mortgage paid during the same year. It is considered relatively easy to understand and one of the most important real estate ROI calculations.
Key Takeaways
Cash-on-cash return measures the amount of cash flow relative to the amount of cash invested in a property investment and is calculated on a pre-tax basis.
The cash-on-cash return metric measures only the return for the current period, typically one year, rather than for the life of the investment or project.
Cash-on-cash return can also be used as a forecasting tool to set a target for projected earnings and expenses.
A cash-on-cash return is a metric normally used to measure commercial real estate investment performance. It is sometimes referred to as the cash yield on a property investment. The cash-on-cash return rate provides business owners and investors with an analysis of the business plan for a property and the potential cash distributions over the life of the investment.
Cash-on-cash return analysis is often used for investment properties that involve long-term debt borrowing. When debt is included in a real estate transaction, as is the case with most commercial properties, the actual cash return on the investment differs from the standard return on investment (ROI).
Calculations based on standard ROI take into account the total return on an investment. Cash-on-cash return, on the other hand, only measures the return on the actual cash invested, providing a more accurate analysis of the investment's performance.
Cash-on-cash returns use an investment property's pre-tax cash inflows received by the investor and the pre-tax outflows paid by the investor. For example, suppose a commercial real estate investor invests in a piece of property that does not produce monthly income.
The total purchase price of the property is $1 million.The investor pays $100,000 cash as a down payment and borrows $900,000 from a bank. Due are closing fees, insurance premiums, and maintenance costs of $10,000, which the investor also pays out of pocket.
After one year, the investor has paid $25,000 in loan payments, of which $5,000 is a principal repayment. The investor decides to sell the property for $1.1 million after one year. This means the investor's total cash outflow is $135,000, and after the debt of $895,000 is repaid, he is left with a cash inflow of $205,000. The investor's cash-on-cash return is then: ($205,000 - $135,000) / $135,000 = 51.9%.
In addition to deriving the current return, the cash-on-cash return can also be used to forecast the expected future cash distributions of an investment. However, unlike a monthly coupon payment distribution, it is not a promised return but is instead a target used to assess a potential investment. In this way, the cash-on-cash return is an estimate of what an investor may receive over the life of the investment.
What Does Cash-on-Cash Return Tell You?
Cash-on-cash return, sometimes referred to as the cash yield on a property investment, measures commercial real estate investment performance and is one of the most important real estate ROI calculations. Essentially, this metric provides business owners and investors with an easy-to-understand analysis of the business plan for a property and the potential cash distributions over the life of the investment.
Are Cash-on-Cash Return and ROI Identical?
Though they are often used interchangeably, cash-on-cash return and ROI (return on investment) are not the same when debt is used in a real estate transaction. Most commercial properties involve debt and the actual cash return on the investment differs from the standard return on investment (ROI). ROI calculates the total return, including the debt burden, on an investment. Cash-on-cash return, on the other hand, only measures the return on the actual cash invested, providing a more accurate analysis of the investment's performance.
How Is Cash-on-Cash Return Calculated?
Cash-on-cash returns are calculated using an investment property's pre-tax cash inflows received by the investor and the pre-tax outflows paid by the investor. Essentially, it divides the net cash flow by the total cash invested.
For example, an investor purchases a property for $1 million putting $100,000 cash as a down payment and borrowing $900,000. The investor also pays $10,000 cash for ancillary costs out of pocket. The investor decides to sell the property for $1.1 million after having paid $25,000 in loan payments that include a principal repayment of $5,000.
This means the investor's total cash outflow is $135,000 [$100,000+$10,000+$25000] and cash inflow is $205,000 [$1,100,000 - $895,000]. So, the investor's cash-on-cash return is 51.85% [($205,000 - $135,000) ÷ $135,000].
Cash on cash return is a metric used by real estate investors to assess potential investment opportunities. It is sometimes referred to as the "cash yield" on an investment. The cash on cash return formula is simple: Annual Net Cash Flow / Invested Equity = Cash on Cash Return.
A relatively simple calculation, an investor can find out their cash-on-cash return by taking the pre-tax cash flow (determined using the income and expense calculations for a property) and dividing that figure by the total amount of cash invested. The resulting figure is the cash-on-cash return.
Cash-on-cash return only measures the return on the actual cash invested out of pocket. Cash-on-cash return is a snapshot of annual cash flow, whereas ROI is cumulative and typically measures returns based on including the eventual sale price.
It is a calculation often used for long-term investments as it focuses on cashflow, signifying whether an investment will generate adequate funds for repaying debts. Although there is no rule of thumb, investors seem to agree that a good cash-on-cash return is between 8 to 12 percent.
There is no hard and fast rule for a good cash-on-cash return. It depends on the market, the location, and the type of rental property that is being purchased. The range varies widely, but a rule of thumb is between 10 and 25%; generally, the lower the rate of return on your investment, the less risk you are taking.
While Yield on Cost provides a broader, long-term perspective on investment performance, Cash on Cash Returns give an immediate, annual perspective based on actual cash flow.
The 50 Percent Rule is a shortcut that real estate investors can use to quickly predict the total operating expenses that a rental property investment is likely to generate. To work out a property's monthly operating expenses using the 50 rule, you simply multiply the property 's gross rent income by 50%.
It encourages diversity as a method of risk management. Applied to real estate, the 2% rule advises that for an investment property to have a positive cash flow, the monthly rent should be equal to or greater than two percent of the purchase price.
Q: What is a good cash-on-cash return? A: It depends on the investor, the local market, and your expectations of future value appreciation. Some real estate investors are happy with a safe and predictable CoC return of 7% – 10%, while others will only consider a property with a cash-on-cash return of at least 15%.
What Are the Limitations of Cash-on-Cash Yield? Real estate investors can use an asset's cash-on-cash yield to help them determine its investment performance. But, the yield can be overstated because it may not account for certain factors, including taxes a pre-tax measure of return.
One of the most important assumptions a real estate investor makes when performing real estate valuations is to choose an appropriate capitalization rate, also known as the cap rate. This is the required rate of return on real estate, net of value appreciation or depreciation.
Unlike the cap rate formula which should only be used to compare similar properties in the same market, the cash on cash return formula can be used to compare potential cash returns between properties in different real estate markets.
How Is Cash-on-Cash Return Calculated? Cash-on-cash returns are calculated using an investment property's pre-tax cash inflows received by the investor and the pre-tax outflows paid by the investor. Essentially, it divides the net cash flow by the total cash invested.
Make the Down Payment as Low as you Can – The less you put down, the better the cash on cash return will be. ...
Negotiate the Lowest Sales Price – One of the top tenets of investment real estate is that you make your money on the buy – that is to say by buying at below market value.
Let's say you bought a property for $300,000 in an all-cash deal and you charge $3,000 per month when you rent out the property. That means you're making $36,000 on the rent for the year. Your cash-on-cash return is 12% back per year ($36,000 ÷ $300,000 = 0.12).
To calculate your cash-on-cash return, you would subtract $24,000 from your estimated annual pre-tax cash flow (the $36,000 in annual rent payments). Then, you would divide this number by your initial investment costs (the $50,000 down payment and the $10,000 closing costs). Your cash-on-cash return would be about 20%.
It is a fairly simple calculation that is reached by dividing the annual pre-tax cash flow by the total cash invested. For example, if an investor puts $100,000 cash into the purchase of an apartment building and the annual pre-tax cash flow they receive is $10,000, then their cash-on-cash return is 10%.
Introduction: My name is Rueben Jacobs, I am a cooperative, beautiful, kind, comfortable, glamorous, open, magnificent person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
:max_bytes(150000):strip_icc()/Cash-on-Cash-Return-V2-41503e65175e4572b6b61271eb63a1ce.jpg "Cash-on-Cash Return in Real Estate: Definition, Calculation (1)")
