Working out numbers might not be a hobby for everybody but calculating cash on cash return is an absolute must.
This blog post is meant for all beginner real estate investors struggling with understanding the cash on cash return formula. Sure enough, we are going to break it down for you so that you understand the concept and the exact steps associated with it. So, here is how to calculate cash on cash return:
Related: How to Calculate Cap Rate vs. How to Calculate Cash on Cash Return
Step #1. Understand the concept
There is no doubt that you must get a better understanding of whatever you are working with. So, what is cash on cash return?
The easiest way to explain the CoC return is by saying that it is an evaluation metric. When buying an investment property, it is important that you perform real estate investment analysis. This type of analysis looks into the potential return on investment a property can produce. Therefore, the cash on cash return calculation is a process that helps estimate this rate of return by relying on the amount of potential income relative to the actual amount you have invested.
Related: Investment Analysis Software: Real Estate Investing
This leaves us with the importance of calculating cash on cash return which is the next step.
Step #2. Why is calculating cash on cash return important?
When you calculate the cash on cash return and you end up with a high rate, that is good news. This basically means that your investment property is producing a good income considering the overall sum you’ve invested in cash.
However, before you decide whether the figure you got is a high one, you must know what is a good cash on cash return in real estate investing. For many real estate investors, the best real estate investments have an 8% CoC return or above. Still, some successful real estate investors won’t settle for less than 20%. Of course, as a beginner, if you get your hands on a deal that promises such a high rate, well done. But, if you don’t, do not feel pressured as long as the overall investment property analysis points to success.
Step #3. Break down the cash on cash return formula
At a glance, the cash on cash return formula might seem too simple. However, this doesn’t mean that calculating cash on cash return is as simple. If you do not understand the meaning of each component and where it came from, it is pretty hard to get to an accurate evaluation.
Simply, the cash on cash return formula looks like this:
Cash on cash return = Net Operating Income (NOI)/ Cash invested
When looking at the formula, immediately you understand that the cash invested is as straightforward as it sounds. It is the amount of money you paid from your own pocket. This means that you exclude any investment property financing resources.
On the other hand, when you look at the first component, it is not as simple as it seems. So, what is the Net Operating Income (NOI) after all?
The Net Operating income for calculating cash on cash return:
The NOI is one of the real estate basics an investor cannot miss. It is simply the cash flow an investment property produced throughout a certain year. So, how to calculate cash flow in order to come up with the NOI?
The cash flow is whatever you are left with after paying all the property’s monthly expenses. This means, if you own a rental property that produces $1500 in rental income on a monthly basis and you pay $500 in property expenses, your cash flow is $1000/mo. Therefore, the cash flow formula should look like this:
Cash flow = Rental income – Rental expenses
As you can see, the rental income and expenses are the components that make up the cash flow formula, thus, making them vital for calculating cash on cash return. Still, how do you calculate the Net Operating Income (Annual cash flow)?
There are two ways you can come up with the NOI: you either multiply or add numbers. When you have the same amount of cash flow coming in each month, you can multiply the cash flow by 12. However, if your monthly cash flow isn’t stable, you should add up the values.
Step #4. Proceed with calculating cash on cash return
Now that you understand what everything means, it is time to apply the cash on cash return formula. So, here is an example:
Let’s take the previous example of a rental property that produces $1500 on a monthly basis. The monthly cash flow is $1000 except for two months in which the property produced $800. This rental property cost you $150,000 for which you paid $30,000 from your own pocket.
The first step would be to figure out the NOI by adding up the monthly cash flow. (10*1000) + (2*800) = $11,600.
The second step would be to apply the numbers to the formula:
Cash on cash return = Net Operating Income / Cash invested
CoC = $11,600 / $30,000 = 0.386 * 100% = 38.6%
Step #5. Make a decision!
Finally, after calculating cash on cash return, it is time to decide whether you should invest in that particular property or not. Looking at the figures in the previous example, the property indicates a high cash on cash return which reflects positively on the investment property analysis process. It means that the property is a good investment.
Now, this way of calculating cash on cash return is easy for some investors. To others, however, it is not. As the experts we are, we’ve got the perfect solution for you: the investment property calculator. This amazing tool is what you can use as a cash on cash return calculator to perform this process in the most accurate way.
Related: Use an Investment Property Calculator and Become a Better Real Estate Investor in 2018
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