Understanding Cash on Cash Return: A Crucial Metric in Real Estate Investment

By: ROS Team

Investing in property encompasses many financial aspects that buyers look at to foresee how lucrative an investment may be. One such pivotal measure is the Cash on Cash Return (COCR). This measure is essential for buyers to gauge how well and worthwhile their property ventures are faring.

In this guide, we’ll explore what the Cash on Cash Return means, how you can calculate it, and why it is crucial for making smart choices in the property market.

What Is Cash on Cash Return?

Cash on cash return is a simple but powerful metric that measures the annual pre-tax cash flow generated by a rental property relative to the total cash invested in the property. In other words, it tells you how much of your out-of-pocket investment you’re earning back each year.

How to Calculate Cash on Cash Return?

Cash on Cash Return Formula is relatively straightforward:

Cash on Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested

What Is an Example of a Cash on Cash Return in Real Estate?

Suppose you buy a rental property for $100,000 and put $20,000 down (20% down payment).
The property generates $12,000 in annual rental income, and your annual expenses (including mortgage interest, property taxes, and insurance) are $8,000.
Your annual pre-tax cash flow would be $12,000 (rental income) – $8,000 (expenses) = $4,000.
Your cash on cash return would be $4,000 (pre-tax cash flow) / $20,000 (total cash invested) = 20%.

In this example, your cash on cash return is 20%, meaning you’re earning a 20% annual return on your out-of-pocket investment.

Why Cash on Cash Return Matters?

Risk Assessment:

The cash on cash return, or COCR, acts as a gauge for investors to evaluate the risk tied to a specific investment opportunity. A higher COCR demonstrates a more favorable return compared to the amount invested, rendering the property more enticing for potential backers.

Comparison Across Investments:

When considering different investment opportunities, investors frequently weigh several prospects at once. Comparing the cash on cash returns enables informed selection by opting for properties yielding the best returns relative to the invested capital.

Leverage Considerations:

The Cash on Cash Return metric takes into account how leverage, or financing, impacts an investment’s performance. If a property is purchased using a loan, COCR reveals how well the investment is generating returns relative to the cash invested, whether those funds came from the investor’s pocket or were borrowed.

Income Stability:

COCR assesses the annual net operating income of a property relative to the initial cash invested. A positive COCR implies that the yearly profits cover operational expenses and mortgage payments, indicating a reliable cash flow for investors.

Decision Making Tool:

Cash on Cash Return is a valuable tool for decision-making in real estate investment. By comparing this metric across different properties, investors can identify the most lucrative opportunities and allocate their resources strategically.

What Is a Good Cash on Cash Return?

A “good” cash on cash return depends on various factors but generally falls between 8-12%. However, consider your risk tolerance and the local market when evaluating what’s acceptable for you.

Cash on Cash vs. ROI vs. IRR vs. Cap Rate: What’s the difference?

Cash on Cash Return (COCR), Return on Investment (ROI), Internal Rate of Return (IRR), and Capitalization Rate (Cap Rate) are all crucial metrics in real estate, each offering unique insights.

COCR focuses on the annual pre-tax cash flow relative to the total cash invested. Return on Investment is a broader metric, considering overall returns, including both cash and non-cash gains or losses.

Internal Rate of Return measures the profitability of an investment over time, accounting for the time value of money and future cash flows. Capitalization Rate assesses a property’s potential return based on net operating income and market value.

Investors frequently employ a group of metrics including COCR, ROI, IRR, and Cap Rate to obtain a well-rounded perspective on a real estate investment’s execution and prospective opportunities. Though COCR and ROI are more elementary assessments, IRR and Capitalization Rate furnish more comprehensive analyses, incorporating elements such as timeframe and property valuation.

When to Calculate Cash-on-Cash Return?

There are several key moments when calculating cash-on-cash return (CoC) proves valuable in real estate investing:

Evaluating Potential Investments

This is possibly the most frequent scenario. Before making the decision to invest in a property, it’s crucial that you fully grasp the Cash on Cash return. This provides a clear image of the yearly pre-tax cash flow you’re likely to receive in comparison to the initial cash you put in. This invaluable insight guides you in comparing diverse options and determining whether they align with your anticipated return goals.

Tracking Performance

Once you own a property, CoC helps you monitor its financial health by showing how efficiently it’s generating cash compared to the initial investment. This allows you to identify areas for improvement, like increasing rental income or reducing expenses, to boost your overall return.

Refinancing or Selling

When considering refinancing or selling your property, CoC again provides valuable insights. It helps you evaluate if the updated cash flow justifies refinancing costs or if the projected CoC upon selling aligns with your investment goals.

Benchmarking Against Market

Comparing your property’s cash flow to typical yields in your area or similar properties allows you to assess its performance relative to others. This crucial step provides insight into your investment’s competitiveness within the industry and helps pinpoint where potential enhancements may boost returns.

Setting Investment Goals

CoC can be used to set realistic investment targets. By factoring in your desired return, risk tolerance, and investment timeline, you can use CoC to identify properties that align with your financial objectives.

Cash on Cash Return: Bottom Line

When evaluating real estate investments, it is crucial to look beyond just cash on cash return as the lone indicator. This metric alone does not account for additional elements that can impact your investment over time, such as changes in the property’s value through appreciation depreciation, or tax implications.

However, cash on cash return serves as a useful measure for assessing a property’s cash flow potential and allowing for well-informed choices regarding that specific investment opportunity.