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].
Cash on cash return is a metric used by real estate investors to assess potential investment opportunities. 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.
Cash-on-cash return only measures the return on the actual cash invested out of pocket. Cash-on-cash return is a snapshot of annual cash flow, whereas ROI is cumulative and typically measures returns based on including the eventual sale price.
However, a cash on cash return is usually a percentage expressed on an annual basis, whereas an equity multiple is often calculated over a multi-year period. An equity multiple also often includes the sale of the property by the investor in the calculation.
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%.
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.
Let's say you bought a property for $300,000 in an all-cash deal and you charge $3,000 per month when you rent out the property. That means you're making $36,000 on the rent for the year. Your cash-on-cash return is 12% back per year ($36,000 ÷ $300,000 = 0.12).
There is no hard and fast rule for a good cash-on-cash return. It depends on the market, the location, and the type of rental property that is being purchased. The range varies widely, but a rule of thumb is between 10 and 25%; generally, the lower the rate of return on your investment, the less risk you are taking.
Also, as a pre-tax measure of return, it does not take taxes into consideration. For example, if an apartment priced at $200,000 generates monthly rental income of $1,000, the cash-on-cash yield on an annualized basis would be: 6% ($1,000 * 12 / $200,000 = 0.06).
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.
Investors should at least seek equity multiples higher than 1. An equity multiple of 1 indicates that investors received their contributions back. Any multiple less than 1 means that the property had negative returns, and any multiple higher than 1 means the returns were positive.
MOIC stands for "Multiple on Invested Capital” – a financial metric used to evaluate the value of an investment relative to the initial capital invested. It's worth noting that the term MOIC is often interchangeable with terms like cash-on-cash return and multiple on money (MoM).
The Bottom Line. Return on investment (ROI) and internal rate of return (IRR) are both ways to measure the performance of investments or projects. ROI shows the total growth since the start of the projact, while IRR shows the annual growth rate. Over the course of a year, the two numbers are roughly the same.
Calculate the total cash invested. This is the sum of the down payment, closing costs, and any other expenses incurred when purchasing the property. Divide the annual pre-tax cash flow by the total cash invested. This will give you your cash-on-cash return percentage.
The cash flow before tax is calculated after deducting the loan's debt service, and in this sense it does consider both the principal and interest payments from a loan. However, the cash on cash return does not consider any principal pay down that occurs over the term of a loan.
Cap Rate → The cap rate, or “capitalization rate”, measures the potential yield earned on a rental property investment while neglecting the usage of leverage. Cash on Cash Return → In contrast, the cash on cash return, or “cash yield”, represents the profit earned per dollar of equity invested into a rental property.
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%.
Return on investment (ROI) and internal rate of return (IRR) are both ways to measure the performance of investments or projects. ROI shows the total growth since the start of the projact, while IRR shows the annual growth rate. Over the course of a year, the two numbers are roughly the same.
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.
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.
Introduction: My name is Merrill Bechtelar CPA, I am a clean, agreeable, glorious, magnificent, witty, enchanting, comfortable person who loves writing and wants to share my knowledge and understanding with you.
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