Cash on Cash Return and How is it Calculated

March 16, 20237 min read
Cash on Cash Return and How is it Calculated
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Key Takeaways

  • Calculated on a pre-tax basis, cash-on-cash return is a measure of cash flow relative to a cash investment and is expressed in percentages.
  • Calculating this metric can help determine the potential profitability of an investment opportunity.
  • Cash-on-cash can also be used as a comparison metric to help investors determine which of a number of different properties represents the better investment.

A calculation of the amount of cash flow relative to an amount of cash invested is referred to as a cash-on-cash return. Also sometimes called the cash yield, calculating this metric can help determine the potential profitability of an investment opportunity. Often abbreviated as CoC or CCR, the metric is expressed as a percentage and is also useful for comparing several investments to find the best opportunity.

Calculating Cash Return

Dividing the net annual cash flow by the amount of invested equity will render the cash-on-cash return.

Consider the following scenario as an example:

An investor is deliberating the purchase of an apartment complex, the asking price of which is $10 million. They have $2.5 million to invest and will finance the remaining $7.5 million. Closing costs and fees will total $200,000, which means the investor will be into the deal for $2.7 million out of pocket.

Projections estimate that the annual rental payments will total $1.2 million, of which mortgage payments will consume $550,000. Additionally, operating, maintenance, and improvement costs are estimated to require an additional $200,000.

The first step toward calculating the CoC is to determine the annual net cash flow. This is calculated by subtracting the total expenses of $750,000 from the total gross revenue of $1.2 million.

This renders an annual net cash flow of $450,000. Next, the net annual cash flow of $450,000 is divided by the $2.7 million of invested equity, which renders a quotient of 16.7%.

Thus, the cash-on-cash return for this investment is an estimated 16.7% of the initial investment — assuming that costs and expenses line up as anticipated.

Cash on Cash and Investments

As previously mentioned, one of the most common uses for the metric is helping investors make decisions regarding the potential profitability of investment properties. Investors can compare multiple deals using it, based on information provided by sellers. Another benefit of the metric is that it considers the cost of financing. This can give an investor the opportunity to determine the nature of the financing terms they’ll need to secure to make the investment viable.

Calculating the CoC can also provide investors insight into the expense profile of a potential investment property. The greater the expenses, the lower the CoC and the less desirable an investment is likely to be. Conversely, an investor can also use the expense profile to discover cost adjustments that could help generate more profit from the property.

Cash on Cash vs Similar Metrics

While certainly a useful tool, there are a number of other metrics investors should consider in addition to CoC before making an investment decision. Among these are return on investment (ROI), internal rate of return (IRR), net operating income (NOI) and cap rate.

Return on investment: while similar in concept to cash-on-cash return, ROI differs in that it takes the overall rate of return on a property, incorporating debt and cash, into consideration. Meanwhile, CoC measures the return solely on the actual dollars invested.

Internal rate of return is a measurement of the total interest earned on money invested. IRR, unlike CoC, is based upon the total amount of income generated over the entire course of ownership, as opposed to annually — which is the case with CoC.

Net operating income is a measure of the potential income a property can generate with 100% occupancy — minus operating expenses such as landscaping, utilities, maintenance, and vacancy allowance.

Cap rate is the result of the CoC calculation when there is no debt to consider. In other words, when the property is being purchased with cash—rather than outside financing—the calculation that usually renders the CoC, returns the cap rate instead.

Applying each of these metrics (as appropriate) when considering the purchase of an investment property gives an investor several different angles from which to view the potential for profit.

What Constitutes a “Good” CoC?

As in so many cases, the definition of “good” will vary from investor to investor — based upon their time horizons, cash on hand and risk tolerance. Investors seeking to minimize risk might reduce the amount of leverage they employ with larger equity investments. This will lower the CoC, but it will also reduce the cost of financing.

Generally, an 8% to 10% cash-on-cash return is looked upon as favorable. However, some investors refuse to consider anything less than 15% or 20%. Again, it all depends upon the individual investor’s overriding concerns.

The market in which a property is located can also skew the determination of a “good” CoC vs a “bad” one. Higher costs associated with property acquisition in a highly profitable market will return a lower CoC, as the amount of the equity investment will need to be higher. However, the potential for steady income such a market represents might be viewed as a sufficient tradeoff.

Maximizing CoC Returns

The strategies for improving cash-on-cash return typically entail lowering expenses, implementing property improvements or expanding the base of potential renters.

Thoughtful property improvements can justify higher rents. The resulting enhanced appeal can attract tenants willing to pay more to live in a nicer place. A coat of fresh paint in addition to carefully tended landscaping, contemporary security features and better lighting are attractive draws. Increased demand can equal increased prices, which in turn leads to improvements in CoC.

Finding ways to reduce expenses can also have a positive effect on CoC. Minimizing vacancies and reducing turnover costs are particularly effective in this regard. Responding quickly to tenant concerns, expressing appreciation for timely rent payments and maintaining open communications are good ways to entice tenants into staying put. This, in turn, will improve CoC.

Ensuring that marketing efforts reach solid tenants can improve CoC as well. Creating liaisons with the relocation departments of large employers nearby, as well as advertising vacancies at local colleges and universities, can result in a steady stream of well-qualified applicants. This maintains occupancy at a high level, which can improve CoC.

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Summary

Determining a cash-on-cash return is a quick way to get an idea of the potential of a proposed real estate investment. Expressed as a percentage, one noteworthy advantage of CoC is that it incorporates the servicing of debt in its calculation. Neither cap rate nor net operating income take this element into consideration. However, calculating those metrics are equally useful when evaluating the potential of a real estate investment opportunity.

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