“How to calculate cash on cash return?” I already know what you’re thinking, it’s about time we answered this question! You see, the term CASH ON CASH RETURN is rarely heard outside the real estate world because most other types of investments and investors deal with the term RETURN ON INVESTMENT (ROI). ROI can be very hard to determine in real estate investing unless your rental property is actually sold. On the contrary, the cash on cash return is a much easier number to calculate because it looks at the cash return from rental properties compared to the cash invested. Let’s take a closer look at what cash on cash return really means and how to calculate cash on cash return.
Related: How to Calculate Cash on Cash Return Without a Rental Property Calculator
What is cash on cash return?
Cash on cash return return helps real estate investors to evaluate the long-term performance of their real estate investment. And like with any other evaluation, there is always a formula that will make your life just a bit easier. Cash on cash return is the property’s annual net cash flow divided by your net investment and is expressed as a percentage. As shown below:
Cash on Cash Return = A Property’s Annual Cash Flow/Down Payment (Cash Investment)
How to calculate cash on cash return can be answered in more than one way. You see, some real estate investors like to stick to the old fashioned way of evaluation where they calculate all their numbers using formulas and equations and calculate them by hand. Others like to benefit from the advanced technology forming our world and use a cash on cash return calculator.
Related: What is a Good Cash on Cash Return?
What is a cash on cash return calculator?
A cash on cash return calculator helps to show real estate investors the ratio as a percentage between the property’s cash flow in a particular year, usually before taxes, and the amount of initial cash investment. With Mashvisor’s investment property calculator you can easily find the cash on cash return for your investment property. Learning how to calculate cash on cash return is not hard, but you have to understand the many factors that come with it. For example, two main factors that make up cash on cash return are the annual pre-tax cash flow and the total cash invested.
- Annual Pre-Tax Cash Flow = Net Operating Income – Debt Service
The net operating income (NOI) breaks down into these components: Gross Scheduled Rent + Other Income – Operating Expenses – Vacancies. To better understand how to calculate cash on cash return, we have to break down each component and understand what it stands for:
- Gross Scheduled Rent: This is the amount of rental income you would receive if your rental properties were occupied all the time. It’s basically the amount of income you can expect to receive from your investment property.
- Other Income: This is any other kind of income charged with the rental property: for instance, charged parking spaces or other utilities.
- Operating Expenses: These are the expenses that keep the rental property in service, such as insurance, taxes, maintenance, bank fees, property management, and repairs. Operating expenses do not include debt service nor do they include depreciation.
- Vacancy: If you own a rental property and you want to calculate the cash-on-cash return to understand your investment property’s performance, you will need to use actual vacancy. The actual vacancy should be measured by the number of days your rental property was vacant multiplied by the daily rental rate. This is essentially the rental income you lost, on a daily basis, due to a tenant not being in place.
Related: Why does every real estate investor need a cash on cash return calculator?
So now that you have a good idea of how to calculate cash on cash return, let’s talk about why the cash on cash return is such a good metric. The cash on cash return is a great metric and is widely used throughout the real estate industry among both real estate investors and real estate agents. The primary reason for this is due to the metric’s simplicity in calculating the percentage return. The cash on cash return specifically drills down in the return on the capital invested. It does so by only considering returns that are driven by the property’s net cash flow. It is an essential part of value investing because it does not take into account asset appreciation. The cash on cash return is great for indicating the effect of leverage because it only looks at the net cash flow and compares it to the actual amount of cash invested. Using leverage will decrease your cash on cash return, which makes the metric a good way to measure different levels of financing. It’s easy for real estate investors to understand how to calculate cash on cash return. It’s simply the physical cash you have in hand after 12 months, divided by the physical cash you’ve invested. That is why many property sellers and real estate agents use this calculation when discussing potential return on investment for the properties they are marketing.
Because of its simplicity, the cash on cash return is also a great way to run an investment property analysis. Real estate investors can use it as a screening real estate investing tool when evaluating potential deals. The calculation can be done in literally 10 minutes and will likely get you within 2-5% of the actual return on equity in most situations. If you’re analyzing hundreds of deals a week, a metric like the cash on cash return makes a lot of sense. The cash on cash return also allows investors to easily compare different investments. They can compare rental property to lending, investing in stocks or bonds, and even starting a business. Granted, risk factors are not considered, but the cash on cash return does allow for a universal comparison between different investments.
Related: 10 Most Profitable Airbnb Locations for Cash on Cash Return
A final word
In the end, learning how to calculate cash on cash return is not rocket science. All it takes is a little concentration and some practice, and you’re good to go. Calculating the cash on cash return for your investment property can help you understand your property’s overall performance and can help you make smart and beneficial investment decisions. Be sure to check out Mashvisor and its cash on cash return calculator, which will help you in all your calculations!