Real estate investment is a dynamic and complex field that involves numerous metrics, formulas, and tools to evaluate venture profitability. Of countless real estate investment metrics, cash-on-cash return is one of the most useful. Understanding this metric is essential for investors’ property performance and maximizing their returns in the real estate market.
Understanding Cash-On-Cash Return
Cash-on-cash return in real estate investment is a financial metric used to measure the annual return on investment (ROI) generated by a property relative to the actual cash invested by the investor. It provides a clear indication of the cash flow generated by the property compared to the initial cash outlay, making it a valuable tool for assessing the profitability and efficiency of an investment.
The relevance of cash-on-cash return lies in its ability to offer investors a straightforward and tangible measure of the returns they can expect to receive on their invested capital. Unlike other metrics that may incorporate non-cash elements such as property appreciation or tax benefits, cash-on-cash return focuses solely on the actual cash flow generated by the property.
Advantages of the Cash-On-Cash Return Metric
Here are some of the key advantages you could benefit from when using the cash-on-cash return metric:
- Simple and Transparent: Cash-on-cash return provides a straightforward and easy-to-understand measure of the return on investment.
- Focus on Cash Flow: Unlike other metrics that may incorporate non-cash elements such as property appreciation, cash-on-cash return focuses exclusively on the cash flow generated by the property.
- Factual Decision Making: Cash-on-cash return provides investors with valuable information to drive their investment decisions.
- Risk Assessment: Cash-on-cash return helps investors assess the risk associated with a real estate investment by considering the amount of cash invested and the resulting cash flow.
- Comparative Analysis: By calculating the cash-on-cash return for different investment opportunities, investors can easily compare the relative profitability of each option.
What Does This Metric Tell You?
Cash-on-cash return provides investors with valuable insights into a real estate investment’s performance. As mentioned above, cash-on-cash return helps investors make data-driven decisions using historical data and predictive analysis.
A higher cash-on-cash return indicates that the property generates a greater cash flow relative to the initial investment, thus making it a more attractive investment opportunity. Conversely, a lower cash-on-cash return may signal lower profitability or higher risk associated with the investment.
How Can You Use This Tool?
Investors can use cash-on-cash returns to evaluate the potential ROI of different investment opportunities and determine which properties offer the best value for their investment dollars. By comparing the cash-on-cash returns of various properties, investors can identify lucrative investment opportunities and allocate their capital more effectively.
How To Compute a Cash-On-Cash Return
Computing cash-on-cash return is relatively simple. Divide the annual pre-tax cash flow by the total cash investment to calculate this metric. The formula is as follows:
Cash-On-Cash Return = ((Annual Pre-Tax Cash Flow)/(Total Cash Investment))*100
For example, say you acquired a commercial property for $100,000. You paid $20,000 as a downpayment and took out a $80,000 mortgage. You also paid $10,000 for additional fees and taxes. After a year, you made $10,000 but spent $5,000 on the mortgage and other necessary expenses.
First, you need to calculate your annual pre-tax cash flow. To do this, subtract your annual income from your mortgage payment.
In this example, we’ll get $10,000-$5,000=$5,000.
Next, calculate the total cash investment by adding the downpayment and fees.
In this example, $20,000 + $10,000 = $30,000.
You just need to follow the formula for this next step.
$5,000/$30,000=0.16666.
0.16666*100=16.66 or roughly 17%
Cash-On-Cash Return vs Return on Equity (ROE)
While cash-on-cash return focuses on the cash flow generated relative to the initial investment, return on equity (ROE) measures the return generated on the investor’s equity in the property. ROE considers the property’s appreciation in value, making it a valuable metric for long-term investors interested in building equity over time.
Is Cash-On-Cash Return Similar to Cap Rate?
Although both cash-on-cash return and capitalization rate (cap rate) are used to evaluate real estate investments, they measure different profitability aspects. Cash-on-cash return focuses on the cash flow generated relative to the initial investment, while cap rate measures the property’s net operating income (NOI) relative to its market value. While both metrics help assess investment opportunities, they serve different purposes and provide complementary insights.
Make the Most Out of Your Investment
Cash-on-cash return is a valuable tool for real estate investors seeking to maximize their returns and mitigate risks. By understanding and utilizing this metric effectively, investors can make informed decisions, identify lucrative investment opportunities, and achieve their financial goals in the dynamic and competitive real estate market.
Whether you’re a seasoned investor or just starting in the real estate industry, incorporating cash-on-cash return into your investment analysis toolkit can help you make smarter investment decisions and maximize your returns.
