You’ve probably heard about the cash on cash return formula before, but how exactly can real estate investors use it to find the best investment properties? That’s what we’re going to be getting into.
The Cash on Cash Return Formula in Real Estate Investing
When searching for the best rental properties, a key feature all investors look for is cash flow and profitability, typically in the form of return on investment (ROI). Calculating cash on cash return of a potential investment is one of the simplest and most effective ways to analyze the ROI.
Defining Cash on Cash Return
Basically, the cash on cash return formula represents a form of return on investment analysis. It only considers the pre-tax cash portions of an investment. Sometimes referred to as cash yield, the cash on cash return formula calculates the cash income earned on the cash invested in a property. So any loans or money borrowed for this investment aren’t included in the calculation; only the cash you personally invested is included.
Cash on Cash Return Calculation
It’s fairly simple. Like we said above, in real estate investing the cash on cash return measures the annual pre-tax return the investor made on the property in relation to the down payment and any other cash paid to acquire the investment property. Here’s what the cash on cash return formula would look like:
Cash on Cash Return= Annual Pre-Tax Cash Flow / Total Cash Invested
Now that is the basic formula for real estate investments. However, learning how to calculate cash on cash return for a rental property might be easier if we break down the formula like this:
Cash on Cash Return= (Net Operating Income – Debt Service) / (Down Payment + Closing Costs + Rehab Costs + Other Loan Fees)
The net operating income (NOI) is simply the total income (rent payments and any other source of income produced by the investment property) minus the total expenses. Debt service would be your mortgage payments (principal plus interest).
Using the Cash on Cash Return Formula to Find the Best Rental Property Investments
Determining the best way to evaluate an investment depends on your investment strategy. When it comes to rental properties, your investment strategy is cash flow. The best rentals are ones that can consistently operate with positive cash flow. Here’s how the cash on cash return formula helps in spotting those types of investments:
It’s a Simple Metric
Things could get really confusing during an investment property analysis. All the numbers involved in choosing the right property can be overwhelming. The cash on cash return formula is quite the opposite of that. Its greatest feature is its simplicity. Plugging in a few numbers will immediately give you an idea of how attractive a prospective rental property investment is.
It’s the Ultimate Screening Tool
Continuing on from the first point, the cash on cash return formula isn’t only simple, but it’s quick. Sometimes investors miss out on a great real estate investment opportunity because they spend too much time evaluating a property that ends up being a bust. This is when the cash on cash return formula can play an important role. You can use the cash on cash return of different investment properties to quickly compare them.
If you have an average of what an investment property might yield, as well as how much your budget is for this investment, the cash on cash return formula can quickly help you see the investments with the highest return potential. You can pass on the properties that didn’t hold up and focus more time on evaluating the investments with the potential for high returns.
Of course, doing the calculations manually would not help you to screen rental properties quickly. You will need real estate investment tools to get the job done. Try Mashvisor’s Property Finder which can show you investment properties with high cash on cash return in any market.
What Is a Good Cash on Cash Return?
Before you can actually use the cash on cash return formula to spot the best rental properties, you need to know what kind of cash on cash return the best rental properties have. What is considered “good” cash on cash return varies from one type of property to another and from one location to another.
Expert real estate investors disagree on the numbers, but the general range is between 8 and 12 percent. However, you might run into investors who consider that too low; they wouldn’t consider buying a rental property with a cash on cash return below 20 percent. This is why it’s important to have your investment strategies lined up so you know what to look for.
Learn More: What Is a Good Cash on Cash Return?
How Mashvisor Can Help You Find the Best Rental Properties
The cash on cash return formula is great for the initial steps of finding the best investment opportunities. However, no real estate investor should make an investment solely based on one number. Because of the simplicity of the cash on cash return formula, you can never know everything about a rental property by using it alone. So after analyzing the cash on cash return of a property, you still need to take extra steps.
A more in-depth analysis is required to ensure you’re finding the absolute best rental properties. That’s where Mashvisor comes in. Real estate investing isn’t as simple as the cash on cash return formula. With Mashvisor, the complexity of the financial aspect involved in finding the best rental properties is gone. Our rental property calculator does all the work for you- it comes equipped with a cash on cash return calculator so even the simple calculations are taken care of.
Not only that but if you start out your 14-day free trial with Mashvisor now, you can find the cash on cash return (along with other key ROI metrics) for neighborhood-level markets. This ensures that you’ll find the best rental properties in the best places to invest in real estate.