Although it is not a particularly powerful tool for measuring the profitability of rental income property, the cash on cash return provides an easy way for real estate investors to compare the profitability of similar income-producing properties quickly and therefore has remained a popular rate of return measurement for real estate analysis.
What is Cash on Cash?
The cash-on-cash rate of return – expressed as a percentage – measures the ratio between anticipated first-year cash flow before taxes (CFBT) to the amount of initial cash investment made by the real estate investor to purchase the rental property.
Formula
Cash on Cash Return = Annual Cash Flow / Initial Cash Investment
Where,
- “Annual Cash Flow” is the amount of money the property is expected to generate during the first year of operation before income taxes
- “Initial Cash Investment” (sometimes called the “cost of acquisition”) is the total amount of cash initially invested during acquisition including down payment, loan points, escrow and title fees, appraisal, and inspection costs
Example
Say you plan to invest $100,000 for a property that you are projecting will generate an annual cash flow of 7,250 during the first year of operation. You want to calculate the cash-on-cash rate of return as part of your real estate analysis.
$7,250 (cash flow) / 100,000 (initial investment) = 7.25% (cash on cash return)
Illustration
The cash-on-cash calculation is a fairly easy mathematical procedure once you understand the formula, but allow me to show you another way to make the calculation even easier using my iCalculator real estate calculations solution. It only requires two entries and a click of a button (click image to enlarge).
Source: iCalculator by ProAPOD
Rule of Thumb
The cash-on-cash return is not enough information for you to make the real estate investment. But it can help you compare between several investment opportunities you might be considering so its worth computing.
So You Know
iCalculator makes dozens of real estate calculations with the formulas. You can try it risk-free and save 50% (you pay just $24.95). Click here to learn more and get the discount.
“Although it is not a particularly powerful tool for measuring the profitability of rental income property”…
Maybe calculating a cash on cash return is not a powerful sales tool in comparison to other calculations that add eye catching potential returns when speculation is added, but I can tell you that the real estate bubble would never have gotten to where it got in Las Vegas if all the wannabe real estate investors understood it and used it before buying up properties with negative cash on cash rate of returns back in ’04 through ’06.
Me and my investors stopped buying in ’03 because of using the basic cash on cash rate of return and started selling in ’05 with a simple ROE calculation. Obviously, we all did pretty well and it really was not that complicated.