Cash on cash return (CoC) is a popular rate of return used by real estate investors conducting a real estate analysis because it’s easy to compute and offers investors a “quick read” on a rental property’s profitability.
It can help the investor gauge the profitability an income property against another investment opportunity such as a T-bill, for instance, or to compare similar income properties such as an apartment complex to a commercial real estate office complex.
As a result, it’s not uncommon to see this real estate investing return included in most real estate analysis presentations and typically requested by a majority of real estate investors.
Despite its popularity, however, cash on cash is not a particularly powerful tool for measuring the profitability of rental income property mostly due to the fact that cash on cash doesn’t take into account time value of money which in turn restricts it to measuring a property’s first year cash flow rather than cash flows generated over future years.
Nonetheless, the return is not without validity, and certainly one that those of you who are engaging in investment real estate might want to know about. So it seemed needful to show you how it works.
Cash on cash (expressed as a percentage) is a return that measures the ratio between a rental property’s anticipated cash flow for the first year to the amount of cash a real estate investor initially invests to purchase the property.
In other words, cash on cash expresses what percent of the investor’s “initial cash investment” requirement is attributable to the rental property’s “annual cash flow” (generally before taxes). Okay, but to better understand the formulation, let’s dig a little bit deeper.
- The initial cash investment (or cash invested) signifies the total amount of cash the investor expects to initially invest to purchase the property. Namely, the down payment, loan points, escrow and title fees, appraisal, and inspection costs.
- The annual cash flow is the amount of cash generated by the investment property in the first year of operation before the investor’s income taxes are satisfied.
Here’s the formula:
Annual Cash Flow / Cash Invested = Cash on Cash Return
Let’s say that a real estate investor makes an initial cash investment of $206,050 for a rental property estimated to produce a cash flow of $21,483 in the first year of operation. What is the investor’s CoC return for that first year?
$21,483 / 206,050 = 10.43%
Rule of Thumb
Real estate investment decisions are never made solely on cash on cash return because there are better ways to evaluate income-property investments.
So You Know
All ProAPOD real estate investing software solutions automatically compute CoC and include it inside each of the appropriate real estate analysis reports created by the software.