Cash on cash return is the rate of return on cash invested. It is often associated with the real estate industry, but it can also be applied to other investments. When applied to real estate, it’s based on the amount of cash invested in a property and is calculated on a pre-tax basis.
This cash return metric represents the cash flow for a single year rather than over the life of a real estate project. It has several applications including as a forecasting tool for investing money.
What is a cash on cash return?
Cash on cash return is a way to gauge the cash flows from income-generating assets such as commercial real estate. Cash on cash return is a snapshot of an investment’s annual cash return. This compares with return on investment, which calculates the total return on the property over the entire period of time you own it.
Cash on cash return is a quick and relatively easy calculation that compares the cash received from an investment for a month or a year compared to the cash invested in the property. It’s expressed as a percentage return on the amount invested and can help you compare the return on several potential investment properties.
Cash on cash return can be an important forecasting tool for real estate investors who want to understand the type of cash flow a property could generate in a year. Other factors such as the potential appreciation in property value an investor might expect over time should also be considered.
How do you calculate cash on cash return?
The cash on cash return formula is written out in the following way:
Annual pre-tax cash flow / total cash invested
Let’s take a look at an example using a commercial real estate investment.
We’ll start with pre-tax cash inflows, also known as net operating income. This is the annual amount of rent collected from a multifamily rental property, which we’ll say totals $150,000 in our example. We’ll also subtract $40,000 for the mortgage payments for a total net cash flow (pre-tax) of $110,000 ($150,000 - $40,000).
Our total cash invested would be the down payment on the property ($200,000 in this example) plus any fees paid to a property manager or for other maintenance and operating expenses (which we’ll say add up to $20,000). As a result, our total cash invested is $220,000 ($200,000 + $20,000).
Because the cash on cash return calculation equals the annual cash flow ($110,000) divided by the total cash invested ($220,000), the total cash on cash return rate in this example is 50%. This means that based on the amount put down on the property plus ongoing maintenance and operating expenses, you’ll make a 50% return on your cash investment before taxes each year.
If you’re considering several properties for investment, comparing the cash on cash returns on each can be a good way to evaluate the financial viability of each investment.
Cash on cash return example
|Mortgage payments||- $40,000|
|Annual cash flow||$110,000|
|Maintenance and operating expenses||$20,000|
|Total cash invested||$220,000|
|Cash on cash return
(Annual cash flow / Total cash invested)
($110,000 / $220,000)
What are the benefits of a cash on cash return?
Cash on cash return can be predictive of how an investment might perform over time and is an important tool used by investors who prefer real estate.
Cash on cash return can also be used to compare multiple real estate investment opportunities. For example, if the return is lower for one property is this due to lower rental income than the other property? If so, you can calculate the rent you need and see if you can raise it enough to increase your return.
Another concern about investing in a property with a low cash on cash return is your tax situation. If your property taxes are high, the actual cash yield might not be enough to cover what you owe.
Although there are many benefits of using cash on cash return, you need to look a bit deeper into the potential of any investment property. What is the potential growth in the market in which the property is located? What is the vacancy rate? What types of other real estate properties are in the area?
FAQs about cash on cash returns
What is a good cash on cash return?
It depends on a number of factors. Some real estate investors may be content with a relatively conservative cash on cash return in the 7% to 10% range. Other investors might prefer a cash on cash return around 15% range. What constitutes a good return will also depend on the type and the location of the property as well as your investment goals.
Is return on equity the same as cash on cash?
Return on equity and the cash on cash return from a real estate investment are two different metrics and tell investors two different things.
Return on equity calculates the investor’s return on their equity in the property, which can be a moving target. An investor’s equity is the market value of the property minus any repayment to a lender. Return on equity will fluctuate as the mortgage on the property is paid down and the market value of the property fluctuates up or down over time.
Cash on cash return is based on the amount of cash invested in the property against the cash inflows from the property, usually in the form of rental income.
Can a business have a negative cash on cash return?
Yes, a real estate investment can have a negative cash on cash return. This might be the result of charging rents that are too low or an extended vacancy rate.
A negative cash on cash return does not necessarily indicate that a property is a poor investment. If you think the property can be sold at a decent profit at some point, it could eventually turn out to be a smart investment. This is especially true if you have enough cash flow from other sources to sustain you until you can sell the property for a profit.
However, investing in a property with a negative cash on cash return should not be undertaken lightly. Often the main source of cash is rent. Does the real estate market support raising rents? Are the annual fees and costs to maintain the rental property higher than you might expect? If so, why and what does the future hold here?
Cash on cash return is a key indicator in real estate transactions. It can be a way to compare different types of real estate as you’re learning how to invest in real estate. Looking into the components of the cash inflows and outflows can also help you strategize ways to improve your cash on cash return.
Cash on cash return is just one indicator of the potential return you might expect from a property investment. It pays to be thorough and to understand all financial and operational aspects of any property you might be considering.
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