Investing in real estate can be a lucrative venture, but it’s important to understand how to measure the return on your investment. One such metric that can help you evaluate the profitability of an investment property is the cash-on-cash return. In this blog post, we will explain what cash-on-cash return is and how to calculate it.

What is Cash-on-Cash Return?

Cash-on-cash return is a financial metric that measures the annual return on investment (ROI) of a property based on the amount of cash invested. It provides a clear picture of how much cash flow you can expect to receive relative to the amount of cash you have invested in the property.

Calculating Cash-on-Cash Return

To calculate the cash-on-cash return, you need to know two key figures: the annual cash flow and the total cash invested. Here’s the formula:

Cash-on-Cash Return = (Annual Cash Flow / Total Cash Invested) * 100

Let’s break it down further:

  1. Annual Cash Flow: This is the net income generated by the property in a year. It includes rental income minus expenses such as property taxes, insurance, maintenance costs, and property management fees. It’s important to accurately calculate the annual cash flow to get an accurate cash-on-cash return.

  2. Total Cash Invested: This represents the total amount of cash you have invested in the property. It includes the purchase price, closing costs, and any initial repairs or renovations. Make sure to include all cash outflows related to the property.

To illustrate the calculation, let’s consider an example:

Imagine you purchase an investment property for $200,000. You put down a $40,000 down payment and spend an additional $10,000 on closing costs and repairs. Your total cash invested is $50,000.

Over the course of a year, the property generates a net income of $8,000. This includes rental income of $15,000 and expenses totaling $7,000.

Using the formula, we can calculate the cash-on-cash return:

Cash-on-Cash Return = ($8,000 / $50,000) * 100 = 16%

In this example, the cash-on-cash return for the investment property is 16%.

Interpreting Cash-on-Cash Return

Now that we know how to calculate cash-on-cash return, let’s discuss how to interpret the results. A higher cash-on-cash return indicates a more profitable investment. However, what constitutes a “good” cash-on-cash return can vary depending on various factors such as location, market conditions, and personal investment goals.

Generally, a cash-on-cash return of 8-12% is considered a decent return on investment for residential properties. However, commercial properties or properties located in high-demand areas may have higher cash-on-cash returns.

It’s important to note that cash-on-cash return is just one metric to consider when evaluating an investment property. It should be used in conjunction with other financial indicators such as cap rate, gross rent multiplier, and return on investment to make an informed investment decision.

Conclusion

Calculating the cash-on-cash return is a crucial step in evaluating the profitability of an investment property. By understanding how much cash flow you can expect relative to your investment, you can make informed decisions and maximize your returns.

Remember to accurately calculate the annual cash flow and include all cash outflows when determining the total cash invested. Interpreting the cash-on-cash return requires considering various factors, and it should be used as part of a comprehensive analysis.

Now that you have a clear understanding of how to calculate cash-on-cash return, you can confidently assess the potential profitability of investment properties and make informed investment decisions. Happy investing!