You have probably heard the term being used before, and you’re wondering: what is cash on cash return?
Before you start investing in real estate, it is always recommended to learn about the different metrics and methods for calculating the return on investment in order to be able to determine how much money you’re going to make from investing in any property.
One of the most commonly used metrics in real estate investing is the cash on cash return. This metric is used by most real estate investors, especially when analyzing the projected returns of a rental property.
So, what is cash on cash return in real estate investing? What does it indicate? And how can you calculate it to determine the profitability of a rental property? Let’s find out!
What is Cash on Cash Return?
The CoC is a metric used in real estate investing to project an investment property’s estimated return on investment and how much time it needs to generate enough profits to cover for the cash that you paid for it.
But, what is cash on cash return?
A more concise answer would be to say that the CoC is the rate of return on investment that a rental property will have based on the property’s cash flow as a percentage of the amount of cash that you paid for it.
The difference between the cash on cash return and the cap rate, which is another very popular metric in real estate investing, is that while the cap rate will not account for the method of financing used for the purchase of an investment property (cash or mortgage) and will calculate the return on investment based on the property’s total value, the CoC will only take into account the actual cash that an investor puts towards purchasing the property, leaving out any borrowed money from the calculations.
However, in order to learn what is cash on cash return, let’s put it in the context of real estate investing and look at a few examples of how it is calculated.
How is Cash on Cash Return Used in Real Estate Investing?
The cash on cash return is used in real estate investing to help real estate investors know whether an investment property is worth the purchase or not based on the amount of time it will take the property to pay back the amount of cash that an investor has put in it.
When planning your investment, knowing the CoC value of an investment property allows you to know how many years you need to hold the property before it starts generating pure profits for your investment.
The cash on cash return is typically expressed as a percentage value. If a rental property has an annual cash on cash return of 10%, for example, then that property will need 10 years to pay back the amount of cash invested in it.
Naturally, the higher the CoC the better. A high cash on cash return means that the property’s profits are worth it when compared to the amount of cash that you had to pay for it.
Related: What is a Good Cash on Cash Return?
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How to Calculate the Cash on Cash Return
In order to truly learn what is cash on cash return, you should first learn how to calculate it before you start using it in real estate investing.
The formula for calculating the CoC is fairly simple:
CoC = (Cash Flow / Cash Invested) X 100
To learn what is cash on cash return and how to calculate it, you should also learn about the different components that are included in its calculation. To break it down, let’s take a look at the cash flow.
The cash flow of a rental property is the amount of rental income that is left over after you’ve paid off all the expenses. A rental property’s cash flow can either be positive or negative. A positive cash flow is good, and it indicates that the property’s rental income is higher than its expenses. A negative cash flow, on the other hand, is a bad sign, and it indicates that the rental income that the property is generating is not sufficient for paying off its expenses. The cash flow of a rental property, then, is the actual profit that the rental property is generating.
Based on this, if you have an investment property that has an annual rental income of $19,200 ($1,600/month), and annual expenses of $10,000, the annual cash flow of this property would be $9,200.
Now, let’s take a look at some examples when calculating the cash on cash return to help you understand what is cash on cash return and what it means.
Related: 10 Most Profitable Airbnb Locations for Cash on Cash Return
Examples of the Cash on Cash Return
The best way for you to learn what is cash on cash return is to look at realistic examples of the metric and how it is calculated.
For this, let’s make the following assumptions and see how they differ from one case to another:
- Property’s price: $200,000
- Annual Rental Income: $24,000
- Annual Expenses: $14,000
Example #1
For the first example, let’s assume that you are purchasing the investment property using 100% cash.
In this case, the calculations should be straightforward:
CoC = (Cash Flow / Cash Invested) X 100
CoC = ($10,000 / $200,000) X 100
CoC = 5%
This means that this property will generate profits that are equal to 5% of the amount of cash paid for it each year, and would need 20 years to pay off the full amount of cash invested in it.
Example #2
For this example, let’s assume that you are purchasing the property using an 80% mortgage with a payback period of 30 years. For the sake of simplicity, let’s assume that the annual payments plus the interest rate amount to $5,400 per year.
The difference that you will notice in this example is that the cash flow will be much smaller, but the cash invested will also be much less than the previous example. This is because the mortgage payments will be included in the monthly and annual expenses of the rental property, but the amount of borrowed money will be taken out of the cash invested value.
CoC = (Cash Flow / Cash Invested) X 100
CoC = ($4,600 / $40,000) X 100
CoC = 11.5%
As you can notice, the cash on cash return for the leveraged property is much higher than when purchasing using all cash.
When investing in real estate, it is important to find the perfect balance between the amount of borrowed money and amount of cash invested in order to get the best cash on cash return that you are hoping to achieve. However, you should also make sure to account for all expenses and any unexpected expenses that might arise in order to avoid defaulting.
Related: Top Performing Cash on Cash Return Neighborhoods in Pittsburgh
What is Cash on Cash Return – Final Thoughts
The cash on cash return is a very useful metric to use when investing in real estate, especially when purchasing a rental property.
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