A cash-on-cash return calculation, also known as a cash yield, is a relatively easy way for an investor to determine how profitable an investment could potentially be.
What is Cash on Cash Return?
A cash-on-cash return calculation, also known as a cash yield, is a relatively easy way for an investor to determine how profitable an investment could potentially be. Often compared to a return on investment, or ROI, calculation, cash-on-cash is different in that it only considers profits relative to paid investment costs. Appreciation, tax benefits, and many other variables are not included in cash-on-cash calculations.
Calculating Cash on Cash Return
Before you begin, first you must calculate your annual pre-tax cash flow for the property. This will include your gross potential rent and any other income, less your vacancy costs, operating expenses and mortgage payments for the year.
Once you have determined that, your total cash investment is simply the amount of direct capital you have put into the asset. For example, if you purchased a $10 million self storage property with a down payment of $2 million and $8 million in acquisition financing, your total cash investment would be $2 million, not $10 million.
Let’s use the $10 million self storage acquisition mentioned above as an example to illustrate how the formula works.
Using the above as an example, lets say that the recently acquired storage facility has a gross potential rent of $750,000 per year. The facility’s vacancy costs sit at $20,000, operating expenses at around $50,000, and annual mortgage payments come to around $400,000, for a total of $470,000.
Annual Pre-Tax Cash Flow = $760,000 - $470,000 = $290,000
Cash-on-Cash Return = $290,000 ÷ $2 million = 14.5%
Dividing the $290,000 by the $2 million cash invested gives you a cash-on-cash return of 14.5%.
Cash on Cash Return Formula
Cash-on-Cash Return = Annual Pre-Tax Cash Flow ÷ Total Cash Investment
Cash on Cash Return Calculator
What is cash-on-cash return in real estate investing?
Cash on cash return is a rate of return commonly used in multifamily and commercial real estate finance. It is calculated by looking at the amount of cash you invested compared to the amount of income you received over a specific time period, generally one year. It is also called the equity dividend rate in certain cases.
To calculate the cash on cash return, an investor first determines the net income from a specific property for the year. They can do this by determining the gross income the property generated and then subtracting any operating costs (and in the event there is a commercial mortgage, debt service as well). Then, they should divide the net income by the total cash spent for the property. The resulting figure, once converted to a percentage, is the cash on cash return.
The cash on cash return can vary greatly on the same real estate depending on how an investor finances the property. For example, if the investor spends $2 million buying a piece of property, their cash on cash return will be far lower than if they borrows $1.6 million and only spend their cash on a $400,000 down payment and closing costs.
Cash on cash return can be calculated by using the following formula:
Cash on Cash Return= Annual Dollar Income / Total Dollars Invested
How is cash-on-cash return calculated?
Cash-on-Cash Return is calculated by taking the pre-tax cash flow (determined using the income and expense calculations for a property) and dividing that figure by the total amount of cash invested. The resulting figure is the cash-on-cash return.
For example, if you plan to acquire an office building for $9 million and you will invest $5 million directly, taking a mortgage to cover the remaining $4 million, and the annual pre-tax income from the property equals $600,000, and your expenses during this same period are projected to be $350,000, including your loan payments, then your annual net revenue can be calculated as $250,000. The cash-on-cash return can be calculated at 5% for the year, as seen below:
$250,000 ÷ $5 million = 5% cash-on-cash return
What factors affect cash-on-cash return?
Cash-on-cash return is affected by the amount of leverage used to finance the property's purchase value. The more leverage used, the higher the cash-on-cash return. However, loans always involve a certain amount of risk. If the projected net operating income decreased substantially, the owner may be liable to make principal and interest payments or even, at some point, pay back the entire loan prematurely. Income taxes, possible risks, the amount of money to be borrowed, and the various financing alternatives available are the key components to consider before making a decision.
For more information, please refer to this article.
What is a good cash-on-cash return for real estate investments?
A good cash-on-cash return for real estate investments depends on the individual investor's goals and risk tolerance. Generally, a cash-on-cash return of 8-12% is considered a good return. However, some investors may be willing to accept a lower return for a lower risk investment, while others may be willing to accept a higher risk for a higher return.
To calculate the cash-on-cash return, an investor first determines the net income from a specific property for the year. They can do this by determining the gross income the property generated and then subtracting any operating costs (and in the event there is a commercial mortgage, debt service as well). Then, they should divide the net income by the total cash spent for the property. The resulting figure, once converted to a percentage, is the cash-on-cash return.
The cash-on-cash return can vary greatly on the same real estate depending on how an investor finances the property. For example, if the investor spends $2 million buying a piece of property, their cash-on-cash return will be far lower than if they borrows $1.6 million and only spend their cash on a $400,000 down payment and closing costs.
How does cash-on-cash return compare to other real estate investment metrics?
Cash-on-cash return is a useful metric for evaluating the profitability of a potential investment. It is often compared to other metrics such as the capitalization rate, internal rate of return, and debt service coverage ratio. The cash-on-cash return metric is most impacted by the leverage of a given transaction, since leverage dictates the amount of upfront cash an investor is required to put down in order to enter into a commercial real estate investment. Other variables that can affect the cash-on-cash return include borrower tax profile, appreciation or depreciation of the property, associated risk with the rental property, and interest.
For more information, please see the following sources:
What are the advantages and disadvantages of using cash-on-cash return to evaluate real estate investments?
The main advantage of using cash-on-cash return to evaluate real estate investments is that it provides a straightforward figure to determine the current or future profitability of an investment. This can also be helpful in assessing how large of a loan to take.
The main limitation when using CoC calculations is that the metric typically only measures income and expenses during a single year. This can cause some discrepancies in calculating a property’s long-term profitability, as many commercial real estate investors factor in proceeds of the asset’s eventual sale. However, CoC calculations will not include that revenue until the year the property is actually sold.
Another limitation is in terms of using CoC as a predictor of your return. If a property needs unplanned capital improvements — such as replacing a roof or upgrading an HVAC system — this will significantly impact your expected net income from the investment, thus throwing off the accuracy of a forecasted cash-on-cash return.
Finally, cash-on-cash return metrics may not accurately reflect the quality of an investment, particularly if the property is undergoing significant rehabilitation or upgrades — the rental income from a largely vacant multifamily asset undergoing extensive capital improvements may not reflect the investment upside due to the lack of rental revenue.