In 2019, over 5 million existing homes were sold in the United States. Over the last two years, the construction of multifamily properties has increased by 21%, as cash on cash return for rentals continues to grow.
Real estate can be an excellent investment, but it’s essential to determine the profitability of a property before purchase. Cash on cash return is a metric used by investors everywhere to determine how profitable an investment property is.
Do you want to learn how to calculate cash on cash return? Keep reading to learn more about cash on cash return in real estate and for a break down of the cash on cash return formula!
What Is Cash on Cash Return?
Cash on cash return is one of the primary metrics used by real estate investors to determine the future or current profitability of a specific investment property.
The formula calculates the net income produced by a property. The net income is analyzed relative to the initial cash used to purchase the property previously. The metric reveals how much of one’s out-of-pocket total cash investment you’re earning back every year.
Simply put, cash on cash return measures the yearly return that an investor made on a property in relation to how much mortgage was paid that same year. It’s easy to understand and one of the most significant returns on investment calculations used in real estate.
Cash on Cash Return Formula
Cash on cash return formula is: Cash on cash return = Annual pre-tax cash flow / Total money invested
While the method is relatively easy to calculate and understand, it’s essential to be familiar with these recurring expenses, impacting the calculation:
- Property taxes and insurance
- Maintenance costs
- Property management fees
- Vacancy rate
- HOA fees (when applicable)
- Other operating expenses
Also referred to as the cash yield on investment properties, cash on cash return is used for many commercial investment properties, especially those that involve long-term debt borrowing.
It’s important to remember that when debt is included in real estate transactions, real estate investors take note of a different cash return than that of a standard ROI (return on investment).
Example of Cash on Cash Return
Say, for example, an investor purchases a property worth $2 million. They put down $200,000 of their own money. They borrow the remaining $1.8 million.
The investor pays closing fees, maintenance costs, and insurance premiums out-of-pocket. They amount to $20,000.
After a year, the investor has paid loan payments of $50,000. $10,000 of that is principal repayment. After a year, the investor decides to sell the property for $2.2 million.
The investor’s total cash outflow is $270,000. After the remainder of debt gets repaid, the investor is left with $410,000 of cash inflow.
The cash on cash return would then be: ($410,000 – $270,000) / $270,000 = 51.9%
The cash on cash return is often used to forecast expected future cash distributions, too. However, it’s not a promised return. Rather, it’s used as a target to assess a potential investment. It’s an estimate of what real estate investors may receive over the life of their investments.
What Is a Good Cash on Cash Return?
The determination of good cash on cash is different for everyone. Expressed as a percentage, many real estate investors say that anything over 8% is good cash on cash return.
A lot of real estate investors aim for a rate that’s between 8% and 12%. However, some investors wouldn’t even consider a real estate investment that doesn’t promise more than 20%.
It varies from property to property, too. Location, risks, property type, and many other factors can affect an investor’s rental strategy or the desire to invest.
For commercial properties with more significant risks, investors want to see higher potential cash on cash return. It’s crucial to remember that the return rate varies based on how much gets spent out-of-pocket. How is your cash flow structured?
For example, for investors who invest $0 of their own cash, their cash on cash return would be zero. That’s not to say that an investment is bad under those circumstances, but that the formula wouldn’t be helpful to use as metrics in that particular case.
This is one of the reasons why investors use several formulas to dictate their investment decision-making.
Cash on Cash vs. ROI
Sometimes investors use the terms return on investment (ROI) and cash on cash return (CCR) interchangeably. However, they are not the same at all.
Cash on cash return takes a look at yields relative to any money spent by an investor out-of-pocket. On the other hand, ROI looks at returns on the entire investment, including any loans taken out to finance the venture.
ROI is trickier to measure sometimes, as it looks at returns based on the proposed eventual sale of a particular property. Another way of saying it is that return on investment measures the total wealth buildup of a property. Cash on cash, though, measures how much cash a property should generate from the investment.
It doesn’t factor in tax benefits or real estate appreciation, either.
Because there are so many metrics to consider when looking at a potential investment, investing with a company like Prevalent Capital will ensure you’re making a great investment.
We are honest and transparent, and we will always share both the good and the bad. We share quarterly financial reports and provide monthly updates so that you’re always on the same page as us.
Take a look at our investment strategy to understand better what it’s like to invest with us.
Cash on Cash Return Is a Crucial Metric for Real Estate Investors
If you’re a real estate investor, one of the best things you can do is to grow your understanding of vital metrics like cash on cash return.
It’s essential to ensure that your cash on cash return rate is significant enough for the investment. Make sure that before you make a final decision, you conduct an in-depth analysis to ensure the return that you desire.
Are you thinking about investing with us and want to know more about how that would look? Get started by reaching out and gaining access to our current deals!