Return on Investment: The three words real estate investors should concern themselves with when analyzing potential investment properties. One of the most common return on investment metrics that all real estate investors need to learn about is cash on cash return.
With so many guides out there on how to calculate cash on cash return, it can get a little confusing. Sometimes, real estate investors (especially beginners) can even start to make mistakes when calculating cash on cash return.
That is why it’s important not only to learn how to calculate cash on cash return but also what mistakes to avoid when determining the value of this return on investment metric for investment properties.
Mistake #1: Don’t Be Deceived by the Simplicity of the Formula
The reason most real estate investors learn how to use cash on cash return to analyze the return on investment for rental properties is the simple looking equation:
Cash on Cash Return = Annual Cash Flow/Cash Investment
Sure, it is simpler than most return on investment metrics, but still, a real estate investor will have to gather a lot of information about potential investment properties before calculating cash on cash return. Let’s take a look at what annual cash flow and cash invested each consist of:
Annual Cash Flow = Gross Rental Income + Other Income – Vacancy – Operating Expenses – Debt
Cash Investment = Down Payment + Closing Costs + Pre-Rental Repairs on Investment Properties
Once these aspects of the cash on cash return formula are expanded, things get a little more complicated for the real estate investor. Gathering this information about investment properties is crucial to determining the return on investment, and isn’t as simple as the equation may have lead you to believe.
Click here to use a rental property calculator to easily find cash on cash return for investment properties.
Mistake #2: Don’t Forget About Vacancy of Rental Properties
Many times, real estate investors calculate cash on cash return and forget to subtract the money lost when rental properties are vacant. This is because unless a real estate investor is using the cash on cash return calculation for rental properties he/she already owns, finding out the vacancy rate can be a bit difficult.
The best way to find the potential vacancy rate for rental properties is to use comparative market analysis. While comparative market analysis is usually used for finding the real estate market value of investment properties, a similar technique can be used in this case. Find rental properties in the same real estate market as your potential investment property and investigate their vacancy rate. Talk to landlords and other real estate investors to get this information. Then, take the vacancy rate and multiply it by the rental income. This will be a good estimate of the loss of cash flow from vacant rental properties.
Mistake #3: Don’t Misinterpret Cash on Cash Return
What is a good cash on cash return? If a real estate investor doesn’t know the answer to this, then he/she can end up misinterpreting the results of a cash on cash return calculation.
While it is difficult to come up with a unified answer to the question “What is a good cash on cash return?”, a real estate investor can consider this: Most real estate experts agree anything from 8-12% will provide positive cash flow. Of course, a real estate investment with a higher cash on cash return will be an even better place for your cash investment!
Related: What is a Good Cash on Cash Return?
Mistake #4: Don’t Use Cash on Cash Return for Investment Properties Older Than 12 Months
Cash on cash return can be great to predict the cash flow for the first year of a potential investment property. It can even be great to keep using for that first year a real estate investor owns an investment property. After that, cash on cash return is no longer a useful measure of cash flow. Why? Well, one prominent reason is the fact that cash on cash return doesn’t take into consideration how the cash investment changes. While a real estate investor starts with just a down payment, monthly mortgage payments every year go towards the overall cash investment. The cash on cash return formula doesn’t account for this (as is).
Mistake #5: Don’t Only Rely on Cash on Cash Return
Unfortunately, the cash on cash return metric has limitations, and it can be a mistake to rely solely on this metric to analyze return on investment for potential investment properties. For one, the cash on cash return doesn’t consider any taxes paid on rental properties. While taxes don’t necessarily predict the success or failure of a real estate investment, they definitely affect the overall return on investment and cash flow for every individual real estate investor.
Another limitation of cash on cash return is that it doesn’t take into account investment property appreciation or the equity gained from loan payments.
Related: Cap Rate or Cash on Cash Return: Which Metric to Use When?
Mistake #6: Don’t Forget to Use a Rental Property Calculator
Cash on cash return and other return on investment metrics can be tricky. If a real estate investor ends up with inaccurate results, he/she could end up placing a cash investment in a negative cash flow real estate investment!
Avoid this by using a rental property calculator. A rental property calculator will help determine the cash on cash return on investment properties as well as other return on investment metrics (ensuring you don’t make mistake #5). It can even tell you what is a good cash on cash return. Consider using Mashvisor’s rental property calculator to help choose your next real estate investment.
Click here to start using the best rental property calculator to find and analyze investment properties.
Related: How Can You Find a Rental Property Calculator for The Best Real Estate Investments?
Becoming an expert on cash on cash return for investment properties means knowing exactly what mistakes to avoid! Steer clear of these six common mistakes and find investment properties with the best possible cash on cash return for your real estate investment portfolio. Sign up for Mashvisor to find the expected cash on cash return for investment properties throughout the US.
