If you’re still at the beginning of your real estate investing career, you’re definitely going to need a couple of pointers. Today’s blog is talking about return on investment metrics: cash on cash return vs. ROI.
Real Estate Investing for Beginners: Cash on Cash Return vs ROI
Buying an investment property requires much more than just finding a property and making a purchase. The goal is to make the best real estate investments. One of the most important things many beginners overlook is the investment property analysis. This analysis includes both the metrics we’re going to be discussing today and is very important because, if done with the right resources, it will clearly show you the difference between cash on cash return and ROI on its own. Making money in real estate requires a clear understanding of the different metrics involved in analyzing investment properties. Let’s cover these real estate basics: cash on cash return vs ROI.
Cash on Cash Return
This is one of the most important return on investment metrics in real estate investing. From the name (cash on cash), you can conclude that this metric measures the cash income earned on the cash invested in a property. Sometimes referred to as the cash yield, this metric is normally used to measure the performance of commercial real estate investments, but can also be used in residential real estate investments such as rental properties.
When we say cash on cash return vs ROI, the main difference that comes to mind should be the debt factor. When you take out a mortgage to buy an investment property, the actual cash return on the investment differs from the standard return on investment (ROI). Cash on cash return only measures the return on the actual cash invested, providing you with a more accurate analysis of your investment property’s performance.
Return on Investment (ROI)
Return on investment or ROI is a profitability ratio. Therefore, it measures how much money or profit is made on an investment as a percentage of the cost of the investment. When we say ROI, we’re taking into account the entire cost of this investment property. ROI shows real estate investors how effectively and efficiently investment dollars are being used to generate profits. It also determines how well an investment is performing.
Cash on Cash Return vs ROI: How to calculate them
The main difference between these two metrics is, obviously, the calculations involved in finding each metric. Cash on cash return vs ROI: How do the formulas differ? Let’s get into it.
- Cash on Cash Return= (Annual Pre-Tax Cash Flow/ Actual Cash Invested) x 100%
The basic formula is very simple. You divide the net cash flow generated from the investment property for the year by the cash you actually invested in that property. The annual pre-tax cash flow is found by subtracting your annual mortgage payment from your net operating income (NOI). Net operating income is the total income from the property minus total expenses of the property.
- ROI= Net Profit/ Total Cost
This formula has a more general sense because ROI is used as a measure of profit in many other types of investment. Unlike cash on cash return, which is typically only used in the case of real estate investing. To calculate the gain on an investment through ROI, we take the net profit (net gain) on the investment and divide it by the original cost of that investment.
Cash on Cash Return vs ROI: Which Is Better?
Both cash on cash return and ROI are critical metrics measured in percentages. Real estate investors use both in a return on investment analysis to determine the return and stability of any real estate investment. So when you’re wondering about cash on cash return vs ROI, you’re measuring stability vs total return. The cash on cash return is a better representation of an investment’s stability. Investors look for a high cash on cash return when searching for an investment property. This shows that the property can pay for itself over the long-term and is sustainable.
The ROI is a better measure of total wealth created by an investment. Besides cash flow, there are many other factors which help build wealth through real estate investments. Examples of these other factors would be:
- Appreciation: Real estate property is known to increase in value with time. Having a value-increasing asset is always a plus when trying to build wealth.
- Principal Reduction: Assuming you have a mortgage, you will have to pay down the principal on that loan. The return from your down payment is what is actually building your wealth.
- Tax Advantages: There are many tax-deductible expenses involved with owning an investment property. Expenses claimed on the property will reduce your adjustable gross income by the same amount of expenses. This will, in turn, save you more money on taxes.
So, cash on cash return vs ROI- which one wins? Both. Clearly, the two metrics play a crucial role in the analysis of an investment property. Each represents a different factor, but both are important. Cash on cash return measures how much cash an investment property will actually generate, whereas ROI measures total wealth buildup.
Cash on Cash Return vs ROI: The Easy Way to Find Them
Because these metrics are very important, real estate investors needed a more efficient way of finding them. Manually calculating these metrics and others was a waste of valuable time and effort. Spreadsheets were a more accurate method, but they still required time. So what’s the solution?
An investment property calculator is the way to go. This is a digital tool that will instantly provide you with all the necessary metrics and information needed to make the right decision.
Watch our video below to find out the best cash on cash return calculator for beginner and experienced real estate investors:
You can find a great investment property calculator with Mashvisor. Our real estate investment tools have proven to be invaluable to thousands of real estate investors. Our tools include the cash on cash return calculator, Airbnb profit calculator, and much more. Something for everything. All located on one platform so you can make informed investment decisions. So whether you’re asking about cash on cash return vs ROI, or anything else, Mashvisor has the answer. To learn more about our product, click here.