One of the most important metrics in evaluating the profitability of a real estate investment is the cash-on-cash return, also known as cash yield or the equity dividend rate. A cash-on-cash return is an annual measure of the cash income generated by a real estate investment in relation to the amount of cash invested. It is a useful and quick metric to gain an accurate picture of the profitability of an investment property, and is often used for efficient comparisons when assessing investment properties.
REAL ESTATE • INVESTMENTS • METRICS
The formula for calculating cash-on-cash return is simple:
Cash-on-Cash Return = Annual Cash Flow / Total Cash Invested
The annual cash flow is the net operating income (NOI) generated by the property, which is the total income generated by the property minus all operating expenses. The total cash invested is the amount of cash you put into the property to purchase it, which includes the down payment, closing costs, and any renovation costs.
Let’s say you purchase a rental property for $300,000, and you put down a 20% down payment of $60,000. You also spend $10,000 on closing costs and $20,000 on renovations, for a total cash investment of $90,000. If the property generates $20,000 in net operating income each year, your cash-on-cash return would be:
Cash-on-Cash Return = $20,000 / $90,000 = 22.2%
This means that for every dollar you invest in the property, you can expect to receive a 22.2% return on your investment in cash flow each year.
There are some important pros and cons to keep in mind when using cash-on-cash return as a metric for evaluating real estate investments:
Real estate investors often aim for cash on cash returns that exceed the cost of borrowing funds, such as the mortgage interest rate. This allows them to generate positive cash flow and cover their expenses while also earning a return on their invested capital.
The specific threshold for a good cash on cash return can vary widely, but some investors may consider a cash on cash return of 8% or higher to be satisfactory, while others may target returns of 12% or more.
Here are some tips for using cash-on-cash return effectively in your real estate investment decisions:
Return on investment (ROI) is a metric used to evaluate the profitability of an investment relative to the initial investment. It is calculated by dividing the net profit generated by the investment by the amount of the initial investment. ROI is a simple metric that is widely used to evaluate the profitability of investments across different asset classes.
The internal rate of return (IRR) is a metric used to evaluate the profitability of an investment over time, taking into account the time value of money. The IRR is calculated by discounting the future cash flows generated by the investment back to their present value and comparing it to the initial investment. The IRR takes into account the timing and size of cash flows, making it useful for evaluating investments with complex cash flow structures.
Cash-on-cash return helps assess the return on investment for a specific property, while Net Operating Income (NOI) provides a snapshot of the property’s operating performance and potential profitability. NOI measures a property’s operating income after deducting operating expenses but before deducting debt service (mortgage payments) and income taxes. It represents the property’s ability to generate income from its operations. NOI is calculated by subtracting operating expenses from the property’s total income, and is often used as a basis for determining property value and loan eligibility.
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