Real Estate Cash on Cash Return Explained

Understanding Cash-on-Cash Return in Real Estate Investing

Cash-on-cash return is a crucial metric for real estate investors to evaluate the profitability of a potential Investment property. It measures the annual return an investor can expect on their initial cash investment in a property. In simple terms, a higher cash-on-cash return indicates a more profitable investment as it represents the percentage return on the actual cash invested, not the total property value.

Exploring the Cash on Cash Return Formula

The cash-on-cash return formula helps investors assess the return on their cash flow. This number can assist investors in adjusting rent prices and operating expenses to make the investment more appealing. It also helps investors decide whether to purchase additional properties in the area or explore other options for higher returns.

Understanding the Cash-on-Cash Return Formula

The cash-on-cash return formula consists of two components:

Calculating the Annual Pre-Tax Cash Flow

The annual pre-tax cash flow includes all income sources of the property. This includes rent, parking spaces, events, and other streams of income. Operating expenses, such as property management fees, also need to be factored in when determining pre-tax cash flow.

For example, if a property generates $100,000 from rent and other sources while incurring $60,000 in operating expenses, the pre-tax cash flow would be $40,000.

Determining the Invested Equity

The invested equity is based on the amount invested in the property for the calendar year. If it is the first year of owning the property, the down Payment needs to be included in the calculation. Subsequent years only include mortgage Payments made during that year.

Applying the Cash-on-Cash Return Formula

The cash-on-cash return formula requires finding two numbers. Once these numbers are determined, calculating the formula is straightforward. For example, if an investor pays $80,000 per year for mortgage and expenses while generating $100,000 per year from the property, the cash-on-cash return would be 25%.

Cash Return = ($100,000 - $80,000) / $80,000

Cash Return = $20,000 / $80,000 = 25%

Interpreting the Cash-on-Cash Return

Cash-on-cash return provides insight into how cash Investments are performing. It offers a more accurate assessment of a property's current performance compared to return on investment. Sustainable real estate Investments typically demonstrate positive cash-on-cash returns.

Cash-on-Cash Return vs. Return on Investment (ROI)

Cash-on-cash return and return on investment are two formulas used by real estate investors to evaluate properties. Understanding the differences between them can help investors make informed decisions about their investments.

Key Differences Between Cash-on-Cash Return and ROI

• Scope: Cash-on-cash return focuses on cash flow and expenses for the current year, while ROI considers cash flow and property appreciation.
• Timeframe: ROI looks at the lifetime returns of an asset, while cash-on-cash return focuses on annual cash flow and expenses.
• Cash Investment: ROI considers all aspects of an investment, including financing, while cash-on-cash return only looks at cash invested annually.

When to Use Cash-on-Cash Return vs. ROI

Cash-on-cash returns are ideal for assessing current performance, while ROI is better for analyzing long-term returns and including appreciation in calculations. ROI is particularly useful when planning to sell a property and determining total returns at a certain sale Price.

Pros and Cons of Cash-on-Cash Return and ROI

Cash-on-Cash Return

Pros:

• Focus on cash flow
• Immediate financial snapshot
• Clarity on income
• Useful for leveraged investments

Cons:

• Does not consider property appreciation
• Does not account for depreciation
• Short-term focus
• Limited usefulness in non-leveraged investments

Return on Investment

Pros:

• Long-term performance measure
• Includes property appreciation
• Assists in assessing exit strategy
• Offers versatility

Cons:

• Less emphasis on cash flow
• Dependent on asset sale
• More complex calculation
• Risk of overestimating returns

Both metrics have their place, depending on whether the investor prioritizes immediate cash flow or long-term value Growth.

Determining a Good Cash-on-Cash Return in Real Estate

A good cash-on-cash return typically falls between 8% to 12%, with the number increasing after paying off the mortgage. However, regional variations exist, and assessing cash-on-cash returns in your specific area is crucial. Understanding past performance and setting criteria related to cash-on-cash returns and ROI can lead to better investment decisions.

Factors Affecting Cash-on-Cash Return

• Rental Income: Higher rental income boosts cash-on-cash returns.
• Property Expenses: Lower expenses improve cash-on-cash returns.
• Mortgage Payments: Reduced mortgage payments enhance cash-on-cash returns.
• Vacancy Rates: Lower vacancies lead to higher rental income and, consequently, higher cash-on-cash returns.

Interpreting Cash-on-Cash Return

Cash-on-cash returns signify a property's profit margin. Higher returns indicate sustainable investments, while negative returns suggest overspending compared to rental income. Strong cash-on-cash returns provide flexibility for investors to expand their portfolios and capitalize on margins.

Know Your Cash Flow

Understanding cash flow aids real estate investors in maintaining properties, leveraging assets, and building long-term Wealth. Analyzing cash-on-cash returns offers insights into current property performance and combining it with ROI can help identify trends in investments.

Frequently Asked Questions