What Does Cash on Cash Return Mean in Real Estate?

Understanding cash on cash return is crucial for any real estate investor looking to evaluate the profitability of an investment property. Imagine you’ve just bought a property, and you want to figure out how well your investment is performing. This is where cash on cash return comes into play. This metric helps you assess the return on your actual cash investment, excluding financing or leverage.

To put it simply, cash on cash return is calculated by taking the annual pre-tax cash flow from the property and dividing it by the total amount of cash you invested. The result is expressed as a percentage. For example, if you invested $100,000 in a property and the annual pre-tax cash flow is $10,000, your cash on cash return would be 10%.

Why is this important? Because it gives you a snapshot of the profitability of your investment relative to the amount of money you've actually put in. Unlike other metrics like cap rate or ROI, which consider the total value of the property or include financing in their calculations, cash on cash return is purely about the cash you’ve invested. This makes it a powerful tool for comparing different investment opportunities on a level playing field.

Let’s dive deeper into how you can use this metric effectively. Start by calculating your annual pre-tax cash flow. This involves taking the property’s gross rental income and subtracting operating expenses, such as property management fees, maintenance, and property taxes. If you have mortgage payments, you also need to subtract these from your gross income to find your net cash flow.

Next, gather your total cash investment. This includes the down payment on the property, closing costs, and any additional capital expenditures you’ve made to get the property ready for rent.

Once you have these figures, apply the formula:

$\text{Cash on Cash Return}=\left(\frac{\text{Annual Pre-Tax Cash Flow}}{\text{Total Cash Investment}}\right)\times 100$Cash on Cash Return=(Total Cash InvestmentAnnual Pre-Tax Cash Flow​)×100

To illustrate, let’s consider an example. Suppose you purchased a rental property for $500,000. You made a 20% down payment of $100,000, and your annual pre-tax cash flow from the property is $15,000. Your cash on cash return would be:

$\text{Cash on Cash Return}=\left(\frac{15,000}{100,000}\right)\times 100=15\%$Cash on Cash Return=(100,00015,000​)×100=15%

This 15% return tells you that for every dollar of cash you invested, you’re earning 15 cents annually before taxes. This figure helps you gauge whether the property is worth the investment compared to other opportunities available to you.

Cash on cash return is also helpful in assessing the impact of financing on your returns. For investors who use mortgages to acquire properties, understanding this metric can highlight how effectively their cash investment is generating returns. It can be particularly insightful when comparing properties with different financing structures.

Another advantage of cash on cash return is its simplicity. Unlike more complex metrics, it doesn’t require extensive calculations or assumptions. It’s straightforward and focuses solely on the actual cash outlay and return, making it easy to understand and apply.

However, it’s important to remember that cash on cash return is just one piece of the puzzle. It doesn’t account for appreciation, tax benefits, or other factors that might affect the overall return on investment. Therefore, it should be used in conjunction with other metrics, such as cap rate and internal rate of return (IRR), to get a complete picture of an investment’s performance.

In summary, cash on cash return is a valuable tool for real estate investors, providing a clear measure of how well your cash investment is performing. It’s especially useful for comparing different investment opportunities and understanding the impact of financing on your returns. By calculating and analyzing this metric, you can make more informed decisions and better manage your real estate investments.