Understanding Cash on Cash Return in Real Estate Investments

What is Cash on Cash Return?

Cash on cash return is a way to measure how much cash you earn from a real estate investment each year compared to the cash you put in. It helps investors see how profitable a property is in the short term, without considering long-term value increases or debt payments.

In simple terms, cash on cash return helps to gauge the effectiveness of an investment property, particularly useful for comparing different properties or evaluating the performance of an investment over time.

What is a Good Cash on Cash Return?

Determining what constitutes a good cash on cash return can vary based on market conditions, investment goals, and risk tolerance. However, there are general benchmarks and considerations to guide investors.

General Benchmarks

• 8% to 12%: Typically considered a solid range for a cash on cash return in real estate investments. This range suggests a healthy balance between risk and reward, offering a decent return on the cash invested.
• Above 12%: Often seen as an excellent return, indicating a high-performing investment. However, higher returns usually come with increased risk.
• Below 8%: Might be acceptable for low-risk investments or in highly stable markets. While returns are lower, the stability and lower risk might be appealing to conservative investors.

Factors Influencing a Good Cash on Cash Return

• Market Conditions: In a booming real estate market, higher returns might be expected. Conversely, in a downturn, even modest returns might be considered good.
• Property Type: Different types of properties (e.g.,residential, commercial, industrial) can yield varying returns. Commercial properties often offer higher returns due to longer lease terms and higher rents.
• Location: Prime locations with high demand can command better returns, while less desirable areas might yield lower returns.
• Investment Strategy: Investors focused on long-term growth might accept lower cash on cash returns if they anticipate significant appreciation. Those seeking immediate cash flow will aim for higher returns.

Personal Investment Goals

Ultimately, a good cash on cash return aligns with your investment objectives:

• Risk Tolerance: Higher returns often come with higher risks. Assess your comfort level with potential fluctuations in income and property value.
• Financial Goals: Align your cash on cash return targets with your broader financial objectives, whether they are for steady income, growth, or portfolio diversification.

In summary, while an 8% to 12% cash on cash return is generally considered good, individual expectations and market dynamics play crucial roles in determining what is ideal for each investor. Regularly evaluating your investment performance against these benchmarks can help ensure you're meeting your financial goals.

Cash on Cash Return Formula

The cash on cash return formula is simple and straightforward, making it a popular choice for real estate investors. Here's the formula:

To break it down:

1. Annual Pre-Tax Cash Flow: This is the total amount of cash generated from the property each year before taxes. It includes rental income minus operating expenses and debt payments.
2. Total Cash Invested: This is the initial cash needed to buy the property. It includes the down payment, closing costs, and any other initial expenses.

By dividing the annual pre-tax cash flow by the total cash invested and multiplying by 100, you get a percentage that represents the annual return on your invested cash. This formula helps you quickly assess the profitability of a property and compare it with other investment opportunities.

For example, if your annual pre-tax cash flow is $12,000 and your total cash invested is $100,000, the cash on cash return would be:

12,000 / 100,000 x 100 = 12%

This means you are earning a 12% return on your initial investment each year.

Cash on Cash Return vs. Cap Rate

When evaluating real estate investments, it's important to understand the differences between cash on cash return and capitalization rate. Cash on cash return measures the annual return on the actual cash invested. This metric includes financing costs and is ideal for properties involving debt, showing performance relative to the cash invested.

Cap rate measures the property's income-generating ability relative to its market value. It evaluates potential return without considering financing costs, making it an "unlevered" return metric. Cap rate is useful for comparing properties based on market value and is often used for market analysis.

The key differences between the two are in their focus and application. Cash on cash return includes financing costs and helps with personal financial planning and immediate cash flow benefits. Cap rate excludes financing costs and assesses the property's overall income potential. Understanding both metrics helps investors make well-informed decisions by providing insight into profitability and income potential from different perspectives.

Cash on Cash Return vs. ROI

When comparing cash on cash return with ROI, there are some key points to take into consideration. Cash on cash return evaluates immediate cash flow relative to the cash outlay and includes financing costs, showing the return based on cash invested in the current period.

ROI (Return on Investment) measures the total return over the entire holding period of an investment. It assesses overall profitability from purchase to sale, including all costs and returns over the investment's lifespan, providing a cumulative return metric. ROI is ideal for evaluating long-term profitability and overall investment success.

The key differences between the two metrics are in their time frame and scope. Cash on cash return focuses on the annual return within the current period, including only the cash invested and financing costs. ROI measures the total return over the entire holding period, encompassing total costs and returns, including appreciation and sale proceeds. Cash on cash return is useful for assessing annual cash flow and short-term performance, while ROI provides a comprehensive view of an investment's total return over time. Understanding both helps investors make informed decisions and plan their investment strategies effectively.

Example Calculation of Cash on Cash Return

Understanding how to calculate cash on cash return is essential for real estate investors. Let's go through a more detailed example to illustrate the process.

Scenario

Imagine you purchase a rental property for $500,000. To finance this purchase, you make a down payment of $100,000 and secure a mortgage for the remaining $400,000. Throughout the first year, you incur the following expenses and income:

• Gross Rental Income: $60,000
• Operating Expenses (property management, maintenance, taxes, insurance): $20,000
• Annual Mortgage Payments (principal and interest): $15,000

Step-by-Step Calculation

1. Calculate Annual Pre-Tax Cash Flow
• Gross Rental Income: $60,000
• Minus Operating Expenses: $20,000
• Minus Annual Mortgage Payments: $15,000
• Annual Pre-Tax Cash Flow: $60,000 - $20,000 - $15,000 = $25,000
2. Determine Total Cash Invested
• Down Payment: $100,000
• Other Initial Expenses (e.g., closing costs): $5,000
• Total Cash Invested: $100,000 + $5,000 = $105,000
3. Apply the Cash on Cash Return Formula
• Cash on Cash Return (%) = Annual Pre-Tax Cash Flow / Total Cash Invested x 100
• Cash on Cash Return: $25,000 / $105,000 x 100 = 23.81%

In this example, your cash on cash return for the first year is 23.81%. This means you are earning a 23.81% return on your initial cash investment of $105,000 annually, before taxes. This metric helps you evaluate the immediate profitability of your investment and compare it with other potential investments.

Closing Thoughts

Understanding cash on cash return is crucial for making informed real estate investment decisions and maximizing your profitability. If you're ready to explore profitable opportunities, take the next step and browse our available commercial real estate properties for sale below.

Disclaimer: This page is intended for educational purposes only. The results generated by this calculator are based on user inputs and are not guaranteed to be accurate or indicative of actual future performance. This information is not intended to take the place of financial, tax, or legal advice, nor should it be the only deciding factor in making a business transaction. Each investor is responsible for determining whether an investment is appropriate based on personal insight and financial circumstances