What is Cash on Cash Return?
What is a good cash on cash return?
How do you calculate it?
In this article, I will break down the meaning of Cash on Cash Return so you know all there is to know about it!
Keep reading as I have gathered exactly the information that you need!
Let me explain to you what is cash on cash return and why it matters!
Are you ready?
Let’s get started!
What Is Cash on Cash Return
Cash on cash return is a financial metric used, typically by real estate investors, to determine how much cash income a particular investment has yielded in relation to the cash invested in the property.
In other words, how much money is an investor generating from a real estate property for every dollar injected into the property.
Typically, you calculate cash on cash return for a given one-year period as opposed to the entire life that a real estate property was kept.
It’s a simple metric allowing an investor to quickly measure the profitability of a property during a given period of time.
The more your cash on cash return, the more the real estate property is profitable.
On the other hand, the lower your cash on cash return, the less you are making money with a real estate property.
Cash on Cash Return Definition
How do you define cash on cash return?
Cash on cash return is a measure allowing investors to calculate how much cash an asset is generating in relation to the amount of money invested.
The definition of cash on cash return can be summed up as follows:
As you can see, to calculate your return cash on cash, you are evaluating your investment cash inflow in relation to your investment cash outflow.
Cash on Cash Return Formula
What is the cash on cash formula and how to you calculate it?
In essence, the cash on cash formula can be presented as follows:
Cash on Cash Return = Annual Pre-Tax Cash Flow / Total Cash Investment
For more advanced real estate investors, you can calculate your Annual Pre-Tax Cash Flow as follows:
Annual Pre-Tax Cash Flow = (Gross Scheduled Rent + Other Income) – (Vacancy + Operating Expense + Annual Mortgage Payments)
Let’s use the cash on cash return formula to do a simple calculation.
Calculating Cash on Cash Return
Imagine that you are looking to calculate the cash on cash return on a rental property that you intend to keep for many years.
You will need to invest $150,000 to cover your initial cash down payment, closing costs, and initial expenses.
Your mortgage payments, taxes, and insurance will cost you $2,000 per month.
Then, your property is immediately rented for $3,000 per month every year.
In this example, in your first year, your cash on cash return will be $36,000 cash inflow from rental revenue but $150,000 cash outflow from your investment along with $24,000 for your mortgage payments ($36,000 / $174,000 = 20.6%).
As of the second year, you only have your rental revenue and mortgage payments ($36,000 / $24,000 = 150%).
Cash on Cash Return Calculator
If you do not want to calculate your cash on cash return manually, fortunately, there are many online cash on cash calculators that you can use.
Cash on Cash Return Example
Let’s look at an example of cash on cash return to better understand what it means.
Cash on cash return is typically used to evaluate the actual cash return on a real estate property as opposed to the return on investment.
Imagine that you have a real estate property investment that you are evaluating to purchase having the follow variables:
- Property value: $500,000
- Cash down requirement: $50,000
- Mortgage payments: $2,500 per month (paying off $90,000 in principal)
- Closing fee and other charges: $5,000
- Maintenance costs: $500 per month
- Rental revenue: $4,000 per month
Imagine that you believe that this real estate property will be worth $750,000 in five years from now.
Calculating your cash on cash return will require that you calculate how much cash you put into this investment and how much cash is returned to you.
Over the course of the five years, you will inject the following amounts:
- $50,000 cash down payment
- $150,000 mortgage payments
- $5,000 closing fee and other charges
- $30,000 maintenance cost
- Total cash outflow: $235,000
Then, during your ownership and when you sell the property, you can expect to receive:
- $240,000 rental revenue
- $390,000 sales proceed (sale value of $750,000 less outstanding mortgage of $360,000)
- Total cash inflow: $630,000
Your cash on cash calculation will give you $630,000/$235,000 = 268%
Cash on Cash Return FAQ
Let’s look at some common questions relating to the significance and meaning of cash on cash return.
What does cash on cash return mean
Cash-on-cash return is a financial measure allowing you to calculate the performance of an asset, typically real estate investment properties.
In essence, cash on cash tells you how much you can generate in actual cash by investing in a real estate property.
What is a good cash on cash return
Just like many other financial measures and metrics, it’s hard to say what is a good cash on cash returns applicable to all investments.
Every investment should be analyzed based on its own merits.
For example, if you are looking to invest in commercial real estate property, you may have different cash on cash requirements if you’re considering a residential property, an office building, an industrial plant, and so on.
In a buyer’s market, the cash on cash returns can also be higher than in a seller’s market as you have a better chance of purchasing a property at a lower price.
What’s important is that you assess how much cash you need to invest and how much actual cash you will earn on your investment.
It’s a good idea to compare your COC with comparables so that you get an idea of what should be the average to target.
In essence, the higher your cash on cash return, the better the investment.
What is the difference between cash on cash return and return on investment
Is cash-on-cash the same thing as ROI?
The cash-on-cash return metric is not the same thing as the return on investment metric.
When you calculate ROI, you calculate the total return generated by an investment property (this includes how much you paid off in debt even though you did not receive any money for it).
On the other hand, when you calculate cash on cash, you are only focusing your analysis on the actual cash that you will disburse and generate in a given period of time.
What factors increase or decrease cash on cash returns
To the extent the cash coming in versus that cash you invest remains the same, your cash on cash returns will not change.
However, in real life, cash flows fluctuate and so will your cash on cash returns.
Here are some factors that may affect your cash on cash return on a typical real estate property:
- Your monthly rent
- Your vacancy
- Your operating expenses
- Your maintenance costs
- Your property taxes
- Your down payment
- Your unexpected costs
Why is tax excluded from the cash on cash return calculation
When you calculate the cash on cash return of an investment, your focus should be specifically on the investment itself regardless of who owns the asset or property.
If the same property is owned by two different people, the mere fact that the two investors will have a different tax situation should not lead to different cash on cash measures for the same asset.
As a result, since an investor’s tax situation is specific to that person and is completely independent of the real estate property or investment, the investor’s taxes are excluded from the cash on cash calculation.
Cash on Cash Returns Takeaways
So there you have it folks!
What is a cash on cash return in simple terms?
How to calculate cash on cash return?
Cash on cash ROI is a financial metric allowing you to measure the performance of an investment from the angle of how much cash you had to invest versus how much cash the investment generated in a given period.
Cash on cash is an important metric particularly in real estate where investors look at the performance of a given real estate property generating revenues.
When you’re looking at quickly evaluating the performance of a real estate property for investment, calculating the cash on cash return will give you a good indication (although it’s not an end all be all).
Cash on cash return allows you to see how much cash flow you generate in relation to how much money you invest which is a very concrete way of measuring performance.
Now that you know what is cash on cash, how to calculate cash on cash return, examples of cash on cash return, and why it’s important, good luck with your investment project!
My Investing, Business, and Law Blog
By the way, on this blog, I focus on topics related to starting a business, business contracts, and investing, making money geared to beginners, entrepreneurs, business owners, or anyone eager to learn.
I started this blog out of my passion to share my knowledge with you in the areas of finance, investing, business, and law, topics that I truly love and have spent decades perfecting.
You may find useful nuggets of wisdom to help you in your entrepreneurship journey and as an investor.
I’d love to share the insider knowledge that I’ve acquired over the years helping you achieve your business and financial goals.
Now, let’s look at a summary of our findings.
Understanding Cash on Cash Return
If you enjoyed this article on Cash on Cash Return, I recommend you look into the following terms and concepts. Enjoy!
You May Also Like Related to Meaning of Cash On Cash Return
Average annual growth rate
Cash on cash yield
Internal rate of return
Net operating income
Operating expense ratio
Price to earning ratio
Rate of return ratio
Required rate of return
Return on investment
What are operating expenses
What is closing costs
What is down payment
Related to Financial Ratios
Cash conversion cycle
Cash flow from sales
Key financial ratios
Net operating working capital
Net working capital
Sustainable growth rate
What are accounts payable
What are current assets
What are current liabilities
What is bad debt
What is cash flow
What is insolvency
What is working capital
Working capital turnover