What Is Cash on Cash Return?
Cash on cash return is the cash flow for an investment in a given timeframe divided by the equity invested at the end of the same timeframe. Cash on cash return is also pre-tax, and it’s most often used by:
- real estate investors who want to figure out the suitability of potential real estate investments that are primarily or largely bought with cash, or
- investors that want to see how leverage affects their expected cash returns for an investment
Put another way, cash on cash return is a way to figure out how much cash income you earn based on your cash invested directly into a property. It’s also mostly used for annual estimates rather than monthly or quarterly.
How Do You Calculate Cash on Cash Return?
- cash on cash return = the net operating income (NOI) / total cash investment
Your NOI is your annual rental income for a property minus any operating expenses, including maintenance and repair costs, licenses and other fees, costs for employees, and so on. It’s basically the income you have left after paying for all the expenses needed to maintain the property at a certain livable standard.
Meanwhile, total cash investment is any cash you need to pay in order to make the property operational in the first place. Such cash includes the money you use to pay for it upfront, closing and title costs, rehabilitation or repair costs, any additional loan fees, and anything else.
Cash on Cash Return Calculation Examples
Example 1: Single-Family Home
- Purchase Price: $200,000
- Down Payment: $40,000 (20%)
- Closing Costs: $5,000
- Initial Repairs: $5,000
- Annual Rental Income: $24,000 ($2,000/month)
- Annual Operating Expenses: $6,000
- Annual Mortgage Payments: $12,000
- Annual Pre-Tax Cash Flow: $24,000 - $6,000 - $12,000 = $6,000
- Total Cash Invested: $40,000 + $5,000 + $5,000 = $50,000
CoC Return=(6,000/50,000)×100=12%
Example 2: Multi-Family Property
- Purchase Price: $500,000
- Down Payment: $100,000 (20%)
- Closing Costs: $10,000
- Initial Repairs: $10,000
- Annual Rental Income: $72,000 ($6,000/month)
- Annual Operating Expenses: $18,000
- Annual Mortgage Payments: $30,000
- Annual Pre-Tax Cash Flow: $72,000 - $18,000 - $30,000 = $24,000
- Total Cash Invested: $100,000 + $10,000 + $10,000 = $120,000
CoC Return=(24,000/120,000)×100=20%
Why Is Cash on Cash Return Important?
A cash on cash return can provide a lot of valuable data for making real estate investment decisions. Since it’s essentially the cash yield for a possible property investment, it can give investors or business owners tools so they can come up with a good business plan for the property and figure out cash distribution schedules over the investment’s total lifespan.
In other words, it tells you how to spend your money most effectively over the course of an investment and how much you’ll earn every year or “leg.”
Because of these advantages, cash on cash return is often used for any investment properties that include long-term debt borrowing. Many commercial properties require some debt to be incurred just because of the numbers involved, so the actual cash return for an investment could be dramatically different from the regular calculated return on investment. In these situations, cash on cash returns are pretty helpful.
That’s because the regular return on investment calculations look at the total long-term return on investment, while cash-on-cash returns only look at the return of the actual money invested into a property.
Additionally, you can use cash-on-cash return analysis to figure out how much money you should spend in a given investment period. This, in turn, will let you be flexible with your finances as you manage one or more properties that all draw from a single shared funding pool.
Not to mention that cash-on-cash returns are much easier to understand and calculate, especially compared to other types of return investment formulas. It’s a simple equation: how much cash will you have returned after 12 months given how much cash you invested?
Cash on Cash Return and Leverage
Another way cash on cash returns can be helpful is that they’re good tools to examine the effect of leverage in a potential or given investment deal. Remember, cash on cash returns only ever deal with actual net cash flow, so compare that amount to how much real cash you invest. A cash-on-cash return will be lower if you use more leverage (i.e., borrow more), so you can use these returns to look at multiple different investment strategies.
For instance, wondering if you should go into a deal with a lot of leverage or pay with as much cash as possible? Both routes may be useful, but a cash-on-cash return can cut through the math and show you simple, valuable numbers for analysis.
What Is a Good Cash-on-Cash Return?
A good cash-on-cash return (CoC return) for a rental property can vary depending on market conditions, the investor's goals, and the specific circumstances of the investment. Generally, a CoC return between 8% and 12% is considered good. However, this range can fluctuate based on various factors, including the location of the property, the type of rental (short-term vs. long-term), and the investor’s risk tolerance.
Like with many things in real estate, what makes for a good cash-on-cash return largely depends on property values, location, rental strategies, and other aspects.
Cash on Cash Return Limitations
While cash-on-cash returns are excellent analytical tools to help you figure out the worth of a property, they do have a few limitations. Cash on cash returns doesn’t work when calculating tax benefits for things like real estate appreciation – a huge factor in and of itself for long-term real estate investors!
Like with many other analytical tools, these are best used in conjunction with other financial estimation methods.
Cash on Cash Returns vs. ROI
ROI, or return on investment, is more a ratio of profitability than a measure of your actual cash returns each 12-month (or whatever) period. It’s a little broader of an analysis tool, looking at how much profit you can make when considering the entire cost of an investment, not just your cash investment.
Consider a commercial investment property that you examine using both analysis tools: cash on cash return will show your actual cash returns for that mortgage, while the ROI looks at your long-term and overall profits when considering any additional leverage or debt you took on as well.
ROI is useful for figuring out how well your investment is doing in a broader sense. Both tools are helpful but should not really be compared or seen as competitors. Wise investors will likely use both for a holistic look at their potential returns or when deciding on a new investment.
Cash On Cash Return Bottom Line
A good cash-on-cash return for a rental property typically ranges from 8% to 12%, but higher returns are possible depending on the specific circumstances of the investment. To achieve a desirable CoC return, it's crucial to conduct thorough market research, evaluate properties carefully, and manage them efficiently. Each investor's definition of a good CoC return may vary based on their financial goals, risk tolerance, and investment strategy.
In the end, cash-on-cash returns is an easy-to-use tool to figure out how much of a cash return on investment you can expect in the short term. They are applicable both for cash-only investments and for determining how much leverage may affect a new investment. They’re also a great analysis tool since they’re easy to calculate and even easier to understand – hopefully even more so now that you’ve read this guide!