Cash On Cash Return & What It Means For Real Estate Investors

Key Takeaways

  • Cash on cash return is one of many metrics used to evaluate the profitability of an investment property.
  • In order to calculate cash on cash, you’ll want to first find out your annual cash flow.
  • Although there is no rule of thumb, investors seem to agree that a good cash on cash return is between 8 to 12 percent.

If you’re a rental property investor who’d like to measure the profitability of a real estate deal, you may have run into some difficulty finding a metric that best suits your needs. For instance, return on investment (ROI) measures returns as a function of appreciation or equity, which can be tricky to apply to rental properties. As a result, you should familiarize yourself with the concept of cash on cash return, otherwise known as a metric to help investors measure profitability.

What Is Cash On Cash?

Cash on cash return is one of several metrics used by real estate investors to evaluate the current or future profitability of an investment property. The calculation measures the net income produced by a property, relative to the initial cash investment that was made to purchase that same property. In other words, cash on cash return tells you how much of your out-of-pocket investment you’re earning back each year.


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Cash on cash return

How To Calculate Cash On Cash Return

The formula for calculating cash on cash return is as follows:

Cash On Cash Return = (Annual Cash Flow / Initial Cash Outlay ) x 100%

The steps for calculating cash on cash return can be a bit involved, however, especially if you don’t already know your annual cash flow. This is a calculation that indicates how much rental income you have left, after all expenses have been paid. Here are some typical recurring expenses that will impact calculations:

  • Mortgage
  • Property taxes and insurance
  • Maintenance costs
  • Utilities
  • Property management fees
  • Vacancy rate
  • HOA fees (if applicable)

Preparing an itemized list of your monthly rental income and expenses is the most efficient way to calculate your cash on cash return. This allows you to calculate your monthly and annual cash flow, which are numbers you need to know before you can use the equation. If you are using this formula as a part of your deal analysis, you will need to project your numbers as best as you can. If you need some help with this step, here is a resource on accurately estimating your rental property expenses.

Once you have these numbers, go through the following steps to find out your cash on cash return:

  1. Calculate your monthly cash flow: Using the list you prepared earlier, simply subtract your expenses from your income. Don’t forget to include other sources of income aside from rent, such as pet deposits or laundry fees. For example, let us say that you earn $1,500 per month in rent, but you pay $1,200 in expenses, including your mortgage. This leaves you with $300 in net cash flow each month.

  2. Convert to annual cash flow: Once you have your monthly cash flow, simply multiply the amount by 12 to arrive at your annual cash flow. Continuing with our example above, your annual cash flow is $3,600 ($300 per month x 12 months).

  3. Add up your initial cash investments: Next, add up any cash you paid out-of-pocket when initially acquiring the property. This might include the down payment, closing costs, and any improvements or repairs made to the property before you had any tenants. Let us say you acquired a rental property for $300,000. You took out a mortgage to finance the purchase, but put down a 20 percent down payment of $60,000, plus $8,000 in closing costs out of pocket. In addition, you invested about $2,000 of your own funds to make some repairs. This means that your initial cash outlay totaled $70,000.

  4. Divide your annual cash flow by your initial cash investment: Once you have your annual cash flow and initial cash investment totals, you are now ready to calculate your cash on cash return. Simply take your annual cash flow and divide it by your initial cash investment. From our example, your annual cash flow is $3,600, which you divide by your initial cash investment of $70,000. Your resulting cash on cash return should be roughly 0.0514.

  5. Multiply the resulting fraction by 100%: Because decimals can be difficult to work with, you can convert this figure into a percentage by multiplying it by 100%. The cash on cash return from the example above can be converted to 5.14% (0.0514 x 100%).

  6. Analyze your results: Finally, it’s important to think about what your calculation means. In the example, you calculated a 5.14% return. This means that in one year, you will have earned back just over 5 percent of the initial cash investment you made, which was $70,000.

Differentiating Cash On Cash Vs ROI

Although you might hear investors use the terms cash on cash return (CCR) and return on investment (ROI) interchangeably, they are not the same. While cash on cash looks at returns relative to any cash spent out of pocket, ROI looks at returns on the total investment, including loans that you took out to finance the purchase. Mentioned earlier, calculating ROI for a rental property can get a little tricky, as it typically measures the returns based on the eventual sale price of a property. However, there are ways to get around calculating ROI on a rental property, explained in detail here.

What Is A Good Cash On Cash Return For A Rental Property?

For those wondering what constitutes a good cash on cash return rate, there is no specific rule of thumb. There seems to be a consensus amongst investors that a projected cash on cash return between 8 to 12 percent indicates a worthwhile investment, while others argue that in some markets, even 5 to 7 percent is acceptable. A beginner investor might start off with a lower cash on cash return requirement, and increase their standards as they gain experience and know exactly what to look for in a rental property.

It’s important to note that your return rate will vary greatly, based on how much you spend out-of-pocket and how your cash flow is structured. For example, if you invest zero dollars of your own funds, your cash on cash return would be zero. This doesn’t mean that you have a bad investment on your hands, but in this specific case, the formula is not helpful to you. This goes to show that understanding how a formula works, and what the numbers mean, is just as important as the results. It also demonstrates why investors use a number of different formulas to conduct their deal analyses. Visit this resource on the different rental property calculators that you can refer to in the future.

Summary

If you weren’t familiar with the cash on cash return formula before, you might find yourself using it frequently moving forward. Not only does it allow you to measure returns as a function of your cash flow, but it can also help you decide if a potential deal is viable or how much to put towards a down payment. However, make sure that it’s not the only formula that you rely on. The most successful investors use not one, but several metrics to analyze deals. (If you’re completely new to real estate investing, you’ll want to check out this guide on deal analysis for beginners.) The next time you find a potential investment property, try implementing the cash on cash return metric and find out for yourself how versatile it really can be.

What’s your favorite formula to use when measuring the profitability of a real estate deal? Feel free to share in the comments below:

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