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The Cash-on-Cash Return

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cash-on-cash

Cash-on-cash return is a measurement of the ratio between the cash flow a rental property generates in a particular year (usually before taxes) and the amount of initial cash investment a real estate investor makes to purchase the property.

Cash-on-cash return, which is expressed as a percentage, can certainly be calculated based on revenue projections for any future year. In fact, each of my ProAPOD Real Estate Investment Software solutions include it in the Proforma Income Statement as part of a rental property's ten-year financial performance projection.

But given that the return doesn't account for the time value of money - which enables analysts to regard future dollars in light of today's dollars - most investors typically prefer to limit the return as a measurement of cash flow expected in the first year of ownership only.

So cash-on-cash return is not a particularly powerful "look to" measurement of rental property profitability, nonetheless it does provide investors with a quick and easy way to make "first glance" comparison between various investing opportunities.

For example, if you're looking at two similar-type income properties, you can at least get an idea rather easily which might provide the highest cash return on your investment; or likewise, perhaps, make a comparison between the returns associated with real estate investing opportunities to other types of investment opportunities such as a CD.

Formulation

Cash-on-Cash Return = Annual Cash Flow / Initial Cash Investment

Where,

  • Annual cash flow is all of a property's cash inflows less all of its cash outflow during a twelve month period. Gross rental income less vacancy and credit loss less operating expenses (i.e., net operating income), less mortgage payment. In this case, without any consideration of the owner's income tax liability. In other words, it represents the revenue collected by the owner still subject to IRS taxation.
  • Initial cash investment (sometimes called the cost of acquisition) is the total amount of cash invested during the property acquisition such as down payment, loan points, escrow and title fees, appraisal, and inspection costs.

Example

iCalculator

You're conducting a real estate analysis on a rental income property and want to know what cash-on-cash return you might expect for the first full year of operation based upon the following criteria . The property shows a net operating income (NOI) of $38,570. The debt service (annual mortgage payment) figures out to be $23,472. You're estimating that a cash investment of $130,000 will cover your cost of acquisition.

First, you must figure out your annual cash flow before taxes (i.e., Net Operating Income less Debt Service).

$38,570
-23,472
=15,098

Then you simply divide that amount by the amount initially invested to compute the return.

15,098 / 130,000 = 11.61%


So You Know

The image on the right illustrates how iCalculator computes the cash-on-cash return for this example. Click the image to enlarge

Here's to your real estate investing success.

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James Kobzeff is a real estate professional who has specialized in rental income property for the past thirty years. He freely shares his articles to help others learn real estate investing. He developed and owns ProAPOD Real Estate Investment Software.