Understanding cash-on-cash return in real estate investment
When assessing new investment properties, there are several factors to consider. What are the upfront and ongoing costs? What type of use is the property suited for? What kind of profit can you anticipate?
It can be daunting to sift through the numbers and wade through a sea of terms like cap rate or internal rate of return (IRR), but these tools are invaluable to the financial analysis you’ll need to undertake before making a real estate investment. Another key measure? Cash-on-cash return.
Table of contentsWhat is cash-on-cash-return?How to calculate cash-on-cash-returnExamples of cash-on-cash returnCash-on-cash return vs. return on investment (ROI)What is a good cash-on-cash return rate? Final Thoughts
What is cash-on-cash-return?
Cash-on-cash return, sometimes abbreviated as CoC return and also referred to as cash yield or the equity dividend rate, is an annual measure of a real estate investor’s earnings on a property compared to the amount the investor initially spent to purchase it and make it operational.
This calculation can be useful if you’re trying to get an accurate picture of cash flow (in other words, comparing money in and money out). This is particularly important if you have a choice in your financing and want to know how much cash to invest on a down payment and how big a loan to take out.
Expressed as a percentage, it’s an easy way of measuring profitability—which means you can use it to make quick comparisons when assessing properties for investment.
How to calculate cash-on-cash-return
Put simply, your cash-on-cash return is your annual cash flow (pre-tax) divided by your total cash investment.
To calculate your pre-tax cash flow for the year, you’re going to want to add up your gross rent intake for the year, as well as any other income you might receive from the property, such as incremental rent for parking spaces or storage units. You’ll subtract your operating expenses (property manager, handyman, plumber, gardener, other regular upkeep) and annual mortgage payments, if you have a mortgage, to get your net operating income.
You’ll divide this number by all the money you initially invested into the property, which is your total cash invested. This could involve your down payment (or the total amount of the property if you paid it in cash), closing costs, and any repairs or renovations you made before the property could be rented out. The resulting percentage will tell you your cash-on-cash return.
Cash-on-cash return stays roughly consistent as long as your income from the property and investment into it remain consistent. If your income increases because you’re able to charge more rent for it, that would drive your cash-on-cash return up. If you have to invest more money into an unexpected big repair, your cash-on-cash return will go down.
Examples of cash-on-cash return
Let’s say you buy a rental property for a nice round number like $100,000, and you’re able to pay that amount up front, in cash. If you rent it out for $3,000 a month, but your monthly upkeep costs $1,000, then your annual pre-tax cash flow is $24,000: ($3,000 - $1,000) x 12 months. If you divide by the amount of cash invested ($100,000) that means your cash-on-cash return is 24,000/100,000, or 24%.
Consider another example in which the potential investment costs $200,000 but you take out a mortgage, putting 20% down ($40,000). The monthly rental income and maintenance expenses are the same as in the previous example, but now you also have to pay $1,000 every month towards your mortgage. That means your pre-tax cash flow—the money you take in from the property after debt service—is $12,000: ($3,000 - $1,000 - $1,000) x 12, and your cash-on-cash return is 12,000/40,000, or 30%.
Cash-on-cash return vs. return on investment (ROI)
The cash-on-cash return metric differs from ROI because ROI is all about the overall profitability (how much total gain or loss the property yields) over the entire time you own it, whereas cash-on-cash is a snapshot of an annual cash flow. ROI is cumulative, whereas cash-on-cash is not cumulative. ROI also takes into account all the debt in a property, whereas cash-on-cash is only focusing on the money you pay right now.
In practice, ROI can be projected based on the fair market value of your property, but it can only truly be calculated when you sell a property.
What is a good cash-on-cash return rate?
The idea of a good cash-on-cash return is so subjective, it can be hard to quantify. While 8-12% can be a nice round number, different kinds of investments offer different rates of return, and the rate will, of course, also depend on you as an investor.
If you purchase a property in an all-cash deal, that bottom number in the equation will be much higher. If you have a mortgage to worry about every month, that top number may be lower. That’s why cash-on-cash return rate can be a good metric for comparing several potential properties, or for helping you decide how much to invest up front or how much to take out in a loan.
Cash-on-cash return can help you get a snapshot of your property’s potential, but it is limited in a few important ways. This calculation ignores your specific tax situation and fails to take appreciation or depreciation into account. It can’t tell you what will happen if there’s a fire or a flood, or what expenses you’ll face long term, and it also can’t predict what kind of profit you’ll make when you sell the property.
At the end of the day, cash-on-cash return will tell you what kind of money you’re looking at this year, but it can’t predict the future.
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