Cash on Cash Return

Cash on cash returns are the rate of return calculated by dividing cash flow being produced by a property by the upfront cash investment.

What Is Cash on Cash Return?

Cash on cash return is a financial metric to measure a real estate investment property's return on investment (ROI). It is calculated by dividing the annual pre-tax cash flow by the total cash investment in the property.

In another way, it tells you how much cash flow you receive as a percentage of your initial cash investment. For instance, if you invest $100,000 in a property and receive $10,000 in annual pre-tax cash flow, your cash on cash return would be 10% ($10,000 / $100,000).

How Is Cash on Cash Return Calculated?

The formula used to calculate cash on cash return percentage is:‍

COC Return Percentage = Annual Cash Flow / Total Cash Invested‍

Annual cash flow is the net income generated by the property in a year, and the total cash invested includes the down payment, closing costs, and any repairs or renovations made.

Example Calculation of Cash on Cash Return Percentage:‍

Suppose an investor purchases a rental property for $200,000, which includes a $40,000 down payment and $10,000 in closing costs. After deducting expenses such as property taxes, insurance, and maintenance costs, the property generates an annual cash flow of $24,000.

COC Return Percentage = $24,000 / ($40,000 + $10,000) x 100% = 50%‍

In this example, the cash on cash return percentage is 50%, indicating a solid return on investment for the investor.

What Is a Good Cash On Cash Return Percentage?

A good cash on cash return percentage meets the investor’s individual goals and objectives. While many investors aim for at least 8-10%, some may be willing to accept lower returns if the property offers other benefits, such as long-term appreciation or tax benefits. 

Additionally, investors should consider their risk tolerance when determining the cash on cash return percentage that is right for them. In many cases, investors comfortable with higher risk levels may achieve higher returns over the long term. In contrast, more risk-averse people may prefer to seek lower-risk investments with more stability and predictability.

What Does a Higher Cash On Cash Return Indicate?

A more profitable investment is one with a greater cash on cash return. It indicates that the investor receives a greater annual return on their original investment. The cash on cash return, for instance, would be 10% if an investor invested $100,000 in a property and got a $10,000 yearly cash flow. 8% would be the cash on cash yield if the same property produced an annual cash flow of $8,000 instead. Therefore, having a larger percentage return on the investment is always preferable.

How Does the Type of Property Affect Cash on Cash Return?

The property type can significantly affect the cash on cash return, so it's essential to understand various properties and their impact on the return.

Residential properties like single-family homes, duplexes, and apartments can offer higher cash on cash returns than commercial properties. They have lower entry costs, and the returns are usually stable, ensuring the property remains occupied for long periods.

On the other hand, commercial properties like office spaces, warehouses, and shopping centres have a higher potential for appreciation than residential properties. The lease agreements with commercial tenants usually run for extended periods, and commercial properties often provide higher rental rates per square foot of the property.

Another property type that affects the cash on cash return is the quality of the building. An older building may have fewer amenities and require more maintenance, but the purchase price might be lower than that of a new building. But, a new building requires less maintenance and offers more amenities, but with a higher price point.

Lastly, a property's location plays a significant role in determining the cash on cash return. For instance, a property in a desirable area with a high demand for rental units often commands higher rental rates.

How Can Investors Use Cash on Cash Return to Evaluate the Performance of Their Real Estate Investments?

Investors can use the cash on cash return metric in several ways to assess the success of their real estate assets. First, it enables them to evaluate whether their investment produces a positive cash flow and whether it is sufficient to pay for operating costs and debt service. 

Second, it can be used to compare various investment possibilities and assess the risk-return tradeoff for their investment. Investors can use the cash on cash return to plan future investments, set objectives for current assets, and determine the viability of various investment strategies.

How Does Financing Affect Cash on Cash Return?

When financing is used to acquire a property, the debt taken affects the cash on cash return. The higher the debt, the lower the cash on cash return. The investor and the lender share the cash flow when debt is used to finance a property. The investor pays interest on the debt, reducing the amount of cash flow left for the investor. Therefore, the cash on cash return is lower when the debt is high.

Conclusion

In conclusion, real estate investors can assess the success of their investment properties using the cash on cash return metric. Investors can calculate the real cash return on their investment by dividing the property's annual cash flow by the amount they initially invested. This metric considers the cash flow produced by the asset, the quantity invested, and any financing utilized.