You would rarely hear anyone talk about cash on cash return outside the world of real estate investing.
Most other investments such as stocks are evaluated by the return on investment (ROI), not the cash on cash return. In order to calculate the ROI, you need to know all the money that you made from an investment in addition to the cash that you invested. However, you cannot possibly know how much a rental property will bring you in total before you sell it. Thus, it does not make much sense to talk about ROI when deciding whether to purchase a certain investment property or not.
Instead, the most popular and easy metric to use in real estate investing is the cash on cash return. But what does cash and cash return mean?
What Is Cash on Cash Return?
Also called the equity dividend rate, cash on cash (CoC) return is a metric used for income-generating real estate assets. It is calculated by dividing the cash flow (net operating income) (before tax) by the amount of cash initially invested.
Real estate investors use cash on cash return to measure the net cash flow produced by a property as a proportion of the total amount invested. The CoC return indicates the potential return from a property in a simple form. In principle, the higher the CoC return figure, the healthier the property investment.
For the uninitiated, cash on cash return is different from return on investment (ROI). ROI takes into consideration the entire investment, including debt.
How to Calculate Cash on Cash Return in Real Estate
The CoC return calculation considers the annual traditional or Airbnb rental income before tax less the expenses that come with owning and managing the rental property. Let’s take a look at the mathematical formula for calculating the CoC return.
Cash on Cash Return Formula
The formula for cash on cash return is as follows:
- The Annual Pre-Tax Cash Flow is simply the annual rental income minus the operating expenses.
- The Total Cash Invested is all the cash that you must pay in order to make your rental property operational. It means the amount of money to pay to purchase it, closing costs, rehab costs, and loan fees (if you take a loan from the bank).
Let’s look at examples of the cash on cash return formula in real estate that will hopefully make things clearer.
Related: Investment Property Calculator For Analyzing Real Estate Investments
Calculating CoC Return Example: Without a Loan
So, you buy a rental property that costs $250,000, and you pay the full amount in cash (yes, you are one of those few lucky people who have $250,000 available to invest in real estate). You need to pay another 5% in closing costs and rehab costs. Don’t forget to factor the rehab costs in. It doesn’t make sense to calculate the cash on cash return on your property if you ignore the rehab costs because you cannot rent it out if it’s not in good condition. So, they add up to $12,500 in additional costs. Thus:
Total Cash Investment = $250,000 + $12,500 = $262,500
You can charge $2,100 of rent per month for your rental property. So,
Annual Rental Income = 12 x $2,100 = $25,200
Estimating the operating expenses at a third of the rental income is fair, leaving you with:
NOI = 2/3 x Annual Rental Income = 2/3 x $25,200 = $16,800
Cash on Cash (CoC) Return = NOI/Total Cash Investment = $16,800/$262,500 = 6.40%
So, the CoC return that you could generate from this rental property is 6.40% if you paid the entire amount in cash.
Calculating CoC Return Example: With a Loan
Now let’s face it. How many of us can actually take $262,500 out of our pockets to pay for a rental property in cash? Not that many, right? That’s why we should also look also at the more realistic scenario in which a real estate investor needs to take a bank loan to finance the purchase of their rental property.
In order to allow us to compare the two cash on cash return rates (without a loan and with a loan), we will consider the same property as above.
So, we are buying the $250,000 rental property and pay 25% in cash as a down payment:
Down Payment = 25% x $250,000 = $62,500
We include the same closing and rehab costs of 5% of the total value, adding up to $12,500. Now:
Total Cash Investment = $62,500 + $12,500 = $75,000
Don’t get confused at that stage. When calculating the cash on cash return, we only take into consideration the cash money that we pay right away, which means the down payment. You should not include the bank loan here.
Now we need to calculate the NOI. In addition to the rental income (with a plus) and the operating expenses (with a minus), we have to add the debt service to the equation (with a minus). Assuming an 8% interest loan yields:
Debt Service = 8% x $187,500 = $15,000
NOI = $16,800 – $15,000 = $1,800
To get the new CoC return, simply:
Cash on Cash Return = NOI/Total Cash Investment = $1,800/$75,000 = 2.40%
Thus, the CoC return that you will generate from the rental property if you take a bank loan for 75% of the price is 2.40%.
Related: How to Do Investment Property Analysis
However, just because, in our example, the loan decreased the cash on cash return significantly, it doesn’t mean that it will always happen. Sometimes, taking a loan can actually increase the CoC return; it all depends on the price, the loan amount, the expected monthly rent, etc.
If math is not your forte, you might be starting to worry about how to calculate cash on return for rental property or any property that interests you. There is no need for manual calculations with Mashvisor’s investment property calculator. The cash on cash return real estate calculator will provide you with readily available CoC return for properties of your choice, based on your preferred rental strategy (traditional vs. Airbnb).
What Is a Good Cash on Cash Return?
Determining what is a good cash on cash return depends on a number of factors, such as the method of financing (cash vs mortgage) and the current state of the real estate market. Also, the CoC return varies from one type of property to another, from one location to another, and from one rental strategy to another.
Often, a good CoC return is in the double-digit range. However, experts disagree on the actual numbers. Some say that anything above 8% is good and that they aim for a rate in the 8%-12% range. Other investors would not even bother thinking about a rental property if it doesn’t promise them a CoC return of 20% or more.
Because the cash on cash return is a simple metric, it does not tell us everything about a rental property. For example, it does not factor in real estate appreciation or tax benefits. Thus, it is only an indication of whether a real estate investment could be a good idea or not. However, before making the final decision, you need to conduct a more sophisticated, in-depth analysis to guarantee the return that you are looking for.
Related: Top 5 Major Cities for Buy-and-Hold Investment Properties
Cash on Cash Return vs Cap Rate
Besides cash on cash return, there is another measure that real estate investors use to calculate the rate of return from their property investments. The other metric is called capitalization rate or cap rate for short.
Cap rate refers to the ratio between the net operating income (NOI) of an income-producing real estate asset (such as a rental property) and its current market value (CMV) or sales price. The mathematical formula for the cap rate is as follows:
Cap Rate = [Net Operating Income (NOI) / Current Market Value (CMV)] x 100
Cap Rate = [Net Operating Income (NOI) / Sale Price] x 100
It is important to note that cash on cash return and cap rate are not interchangeable. Calculating the CoC return involves two scenarios: purchasing an investment property (1) in cash, and (2) with a mortgage loan. On the other hand, the cap rate calculation does not take into account the method of financing (cash vs mortgage).
The Best Cash on Cash Return Calculator for Rental Properties
Given the availability of several investment property calculators on the internet, it is important to find the most reliable tool that will help you make accurate and reliable calculations for your rental properties.
Mashvisor provides a cash on cash return calculator to make the process easy and stress-free for all real estate investors out there. Mashvisor’s calculator shows the average traditional and Airbnb CoC return for rental properties in your preferred location or neighborhood. With the most comprehensive and updated data used in analyzing both rental strategies, property investors will be able to choose the optimal investment approach and make the most informed decision.
Because of its simplicity and ease of use, cash on cash return is a very helpful metric when doing investment property analysis. Real estate investors can use the CoC return to look for potentially lucrative deals. Finding an investment property with a good cash on cash return can mean several thousands of dollars in future income.
To help ensure that you’ll be successful in your investing journey, take advantage of Mashvisor’s various rental property investment tools. Its cash on cash return calculator can help you make beneficial and smart decisions related to real estate investing.
To start finding traditional and Airbnb rental properties for sale within your budget with good cash on cash return with just a few clicks, sign up for a 7-day free trial of Mashvisor, followed by a 15% discount on your quarterly or annual subscription.