What is Cash on Cash Return & Why Does It Matter?
Cash on cash return is a crucial metric for real estate investors, as it measures the pre-tax cash income earned on the cash invested in a rental property. It helps investors evaluate the performance of their investment and make informed decisions about future investments. Unlike other metrics, such as cap rate or gross yield, cash on cash return takes into account the actual cash invested in the property, providing a more accurate picture of the investment's profitability.
How to Calculate Cash on Cash Return (The Formula)
The formula for calculating cash on cash return is:
Cash on Cash Return = (Annual Pre-Tax Cash Flow / Total Cash Invested) x 100
Where:
- Annual Pre-Tax Cash Flow is the net operating income (NOI) minus debt service (mortgage payments) and other expenses.
- Total Cash Invested is the sum of the down payment, closing costs, and other upfront expenses.
Step-by-Step Practical Example
Let's say you're considering investing in a rental property with the following characteristics:
| Property Details | Values |
|---|---|
| Purchase Price | $200,000 |
| Down Payment | $40,000 (20%) |
| Closing Costs | $10,000 |
| Annual Rental Income | $30,000 |
| Annual Expenses (Property Taxes, Insurance, Maintenance) | $12,000 |
| Mortgage Payments (P&I) | $15,000 |
Using the cash on cash return calculator, we can calculate the annual pre-tax cash flow:
$30,000 (Rental Income) - $12,000 (Expenses) - $15,000 (Mortgage Payments) = $3,000
The total cash invested is:
$40,000 (Down Payment) + $10,000 (Closing Costs) = $50,000
Now, we can calculate the cash on cash return:
Cash on Cash Return = ($3,000 / $50,000) x 100 = 6%
What is a "Good" Cash on Cash Return? (Industry Benchmarks)
A good cash on cash return varies depending on the market, property type, and investor goals. However, here are some general guidelines:
- 4-6%: A relatively low cash on cash return, often seen in stable, low-risk investments.
- 6-8%: A moderate cash on cash return, suitable for most rental property investments.
- 8-10%: A relatively high cash on cash return, often seen in high-growth or high-risk investments.
- 10%+: An excellent cash on cash return, typically seen in highly profitable or opportunistic investments.
Common Mistakes to Avoid
When calculating cash on cash return, investors often make the following mistakes:
- Ignoring closing costs: Failing to account for closing costs can inflate the cash on cash return and lead to inaccurate investment decisions.
- Not considering debt service: Omitting mortgage payments or other debt service costs can significantly impact the cash on cash return.
- Using inaccurate expense estimates: Underestimating or overestimating expenses can skew the cash on cash return and lead to poor investment decisions.
Frequently Asked Questions (FAQ)
Q: What is the difference between cash on cash return and cap rate?
A: Cash on cash return measures the pre-tax cash income earned on the cash invested, while cap rate measures the ratio of net operating income to the property's value.
Q: How does cash on cash return affect my investment decisions?
A: Cash on cash return helps investors evaluate the profitability of their investment and make informed decisions about future investments, such as whether to hold or sell a property.
Q: Can I use cash on cash return to compare different investment opportunities?
A: Yes, cash on cash return provides a standardized metric to compare the profitability of different investment opportunities, allowing investors to make more informed decisions.