The Cash-on-Cash Return
The Cash-on-Cash rate of return (or CoC) is a measurement of the ratio between the total amount of cash flow a rental income property generates in a particular year (usually before taxes), and the total investment a real estate investor initially makes to purchase the property.
Cash-on-cash is not a particularly powerful "look to" measurement of rental property profitability, but it is popular amongst most investors because it does provide a quick and easy way to make "first glance" comparison between various investing opportunities.
For instance, if you're looking at two similar-type rental income properties CoC can at least rather easily give you an idea which property might provide the highest cash return on your investment, or maybe even enable you to make a comparison between the returns associated with various real estate investing opportunities to other types of investment opportunities such as a CD.
Perhaps the most essential shortcoming of cash-on-cash is the fact that the return doesn't account for the time value of money. That is, the calculation assumes a cash flow amount of a property's financial performance projected twelve months into the future, yet at the same time doesn't enable analysts to regard those future dollars in light of today's dollars (which real estate investors typically want to know).
Nonetheless, given its popularity and regular appearance in real estate analysis presentations, even though it's limited to the rate of return on the cash flow before taxes and most effective as a measurement in the first year of ownership only because it ignores time value, it seemed needful to show you how the return is formulated.
Cash-on-Cash Return = Annual Cash Flow / Initial Cash Investment
- Annual Cash Flow is all of a property's cash inflows less all its cash outflows during a twelve month period. Gross Scheduled Income less Vacancy and Credit Loss less Operating Expenses, less Debt Service (annual mortgage payment). In this case, without any consideration of the owner's income tax liability. In other words, this is revenue collected by the owner that is still subject to IRS taxation.
- Initial Cash Investment (sometimes called the cost of acquisition) is the total amount of cash invested to make the acquisition such as down payment, loan points, escrow and title fees, appraisal, and inspection costs.
Okay, let's consider an example.
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 of $38,570, a debt service of $23,472, and you're estimating that $130,000 cash will cover your cost of acquisition.
Step 1: Compute the property's cash flow. Net Operating Income less Debt Service equals Cash Flow Before Taxes (CFBT).
$38,570 -23,472 = $15,098
Step 2: Calculate the return. CFBT divided by the amount of initial cash investment equals the cash-on-cash return.
$15,098 / 130,000 = 11.61%
Rule of Thumb
As stated earlier, cash-on-cash is not a particularly powerful statistic. Therefore real estate investors would be wise to rely on other better ways to measure the profitability of an income property investment. Still, it's not without its supporters so knowing how to formulate it might come in handy.
Here's to your real estate investing success.