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].
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.
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.
CFROI = (Gross Cash Flow / Gross Investment) x 100%
Gross Cash Flow is the cash generated by the company's operations before interest expenses and taxes. It is calculated by adding back non-cash expenses (like depreciation and amortization) to net income. Gross Investment is the total capital invested in the company.
The difference between this and CoC is that IRR is focused on the total income earned throughout the investors complete ownership of the property, whereas CoC provides an annual segment view of the property.
There is no specific rule of thumb for those wondering what constitutes a good return rate. There seems to be a consensus amongst investors that a projected cash on cash return between 8 to 12 percent indicates a worthwhile investment. In contrast, others argue that even 5 to 7 percent is acceptable in some markets.
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.
Cash flow refers to money you earn from your rental property. It starts with cash your property generates from rent payments and other sources of rental income. Afterward, you calculate the gross cash flow by deducting taxes, property management fees, debts, utilities, and additional operational costs.
Return on sales (ROS) is a measure of how efficiently a company turns sales into profits. ROS is calculated by dividing operating profit by net sales. ROS is only useful when comparing companies in the same line of business and of roughly the same size.
ROI is calculated by subtracting the initial cost of the investment from its final value, then dividing this new number by the cost of the investment, and finally, multiplying it by 100.
It differs from other metrics as follows: Cash on Cash vs. ROI: A property's return on investment is used to measure the overall rate of return on a property, including debt and cash, while cash on cash measures the return of the actual cash (equity) originally invested.
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%.
The cash-on-cash return is typically a measure of operational cash flow and, therefore, excludes any profits realized from a capital event such as sale or refinance.
Cash-on-cash yield has number of limitations. The metric may overstate yield if part of the distribution consists of a "return of capital (ROC)," rather than a "return on invested capital (ROIC)," as is often the case with income trusts. Also, as a pre-tax measure of return, it does not take taxes into consideration.
A “good” cap rate varies depending on the investor and the property. Generally, the higher the cap rate, the higher the risk and return. Market analysts say an ideal cap rate is between five and 10 percent; the exact number will depend on the property type and location.
Real estate investments often target an IRR in the range of 10% to 20%. However, these numbers can vary: Conservative Investments: For lower-risk, stable properties, a good IRR might be around 8% to 12%. Moderate Risk: Many investors aim for an IRR in the range of 15% to 20% for moderate-risk projects.
In this scenario, where a $2,000,000 property was bought with a down payment of $500,000 and it generates $15,000 in monthly rental income, here's how you calculate it: First, determine the annual rental income: $15,000 * 12 = $180,000. Then, calculate the cash on cash return: ($180,000 / $500,000) * 100 = 36%.
50% rule. The 50% rule says a rental property's net cash flow should be 50% or more of the gross rent less the mortgage payment (P&I). Here is the formula you can use for that: Net cash flow = (gross rent x 50 %) - mortgage P&I.
Introduction: My name is Nathanael Baumbach, I am a fantastic, nice, victorious, brave, healthy, cute, glorious person who loves writing and wants to share my knowledge and understanding with you.
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