The cash on cash return formula is a useful way to measure the profitability of a real estate deal. When evaluating potential properties, the cash on cash return formula can provide useful insights to help you determine if it is the right deal for you.
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Ready to learn how to use the cash on cash return formula? Here’s what you need to know.
What is cash on cash return?
Before we dive into the formula for a cash on cash return, let’s talk about what a cash on cash return actually means.
A cash on cash return is the rate of return that measures the cash income earned on the cash invested into a property. Essentially, the cash on cash return metric illuminates the annual return that an investor makes on a property in correlation to the amount of cash invested in the property in a single year.
The end result is a number that you can compare across properties to determine the potential return on the amount of cash you are putting into a property. When you are concerned with the profitability of a property as a real estate investor, this is a key metric to consider.
What is the cash on cash return formula?
When you want to calculate the cash on cash return of a property, you can use this simple formula:
Cash on cash return = Annual before-tax cash flow/total cash invested
To calculate your annual pre-tax cash flow, start by adding up the rental income and other income of a property. Next, subtract out potential vacancies, operating expenses, and the mortgage payments associated with the property.
Once you have the annual before-tax cash flow, it should be fairly easy to move forward. The total cash invested in a property is a number that you should be able to determine quickly. Consider any cash that you have used to facilitate the investment in the property, such as a down payment or renovation expenses.
How do you calculate cash on cash return?
Want to see an example of the cash on cash return formula in action? Let’s take a look at a few examples.
Example 1
Let’s say you bought a turnkey property with a down payment of $5,000. The monthly mortgage payment is $500, the monthly rental income is $1,000, there are no other income-producing opportunities on the property, and you haven’t dealt with any vacancies.
Here’s how to calculate the cash on cash return for this property.
First, determine the annual pre-tax cash flow. With a monthly rental income of $1,000 and a monthly mortgage payment of $500, your pre-tax yearly cash flow is $6,000.
Next, calculate your total cash invested. With this property, you’ve invested $5,000 upfront as a down payment. Finally, divide your annual pre-tax cash flow by the total cash investment.
In this case, you would divide $6,000 by $5,000 and reach the number of 1.2%.
Example 2
Let’s say you bought a property that needs extensive renovations. You put down $10,000 upfront. Additionally, you sink $50,000 into the renovations. The monthly mortgage payment is $1,000, the monthly rental income is $2,500, there are no other income-producing opportunities on the property, and you haven’t dealt with any vacancies.
Here’s how to calculate the cash on cash return for this property.
First, determine the annual pre-tax cash flow. With a monthly rental income of $2,500 and a monthly mortgage payment of $1,000, your annual pre-tax cash flow is $18,000.
Next, calculate your total cash invested. With this property, you’ve invested $10,000 upfront as a down payment. Beyond that, you invested $50,000 into the renovation. With that, you’ve invested a total of $60,000.
Finally, divide your annual pre-tax cash flow by the total cash investment.
In this case, you would divide $18,000 by $60,000 and reach the number of 0.3%.
How do you use the cash on cash return in real estate analysis?
When you are using the cash on cash return as a metric in real estate investing, it can help you understand the investment return on an annualized basis. As an investor, this formula can help you measure the annual return you made on the property relative to the amount of the mortgage paid in a given year.
Although you can use the cash on cash return formula in any investment situation, it is typically used in commercial real estate settings. Real estate investors can use this formula to help to build a business plan for a particular property.
If you have any debt attached to a property, this formula can help you evaluate the effectiveness of the deal.
What is a good cash on cash return?
As with most metrics in real estate, there is not a single number that indicates a good cash on cash return. Instead, every investor has to decide for themselves what they are looking for in terms of a cash on cash return.
In most cases, investors aim for a cash on cash return between 8 and 12%. However, other investors look for high cash on cash return opportunities.
You can decide for yourself what a good cash on cash return is based on your market’s level of competition and your long-term investment strategy. Important, the amount you are looking to finance will play a large role in the cash on cash return of a potential deal. If you are making a large down payment, then the initial cash on cash return may not be that exciting. But you need to factor in your long-term investment goals as well.
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The bottom line
Real estate investing can be a way to achieve your long-term wealth goals. Understanding different metrics as you build towards your real estate portfolio goals can be very helpful. Take some time to learn the basics of real estate investing in our complete guide. It can help you set yourself up for long-term success.
