Understanding Cash On Cash Return
As a real estate investor, you want the deals you make to be profitable ones. When measuring the profitability of your investments, you may do like other investors and rely on ROI, Return on Investment. However, since ROI only focuses on returns as they relate to equity or appreciation, using this with rental properties may not necessarily give you a complete picture. Instead, it is best to learn more about the metric known as cash on cash return.
What is Cash on Cash Return?
When you use the cash on cash return metric, you are using a tool that lets you evaluate the current or future profitability of your investment property. Unlike ROI, cash on cash return measures a property’s net income relative to the cash investment you made to purchase the property. Simply put, it lets you know how much of your initial out-of-pocket investment you are recouping each year.
Why is Cash on Cash Return Important?
This metric is vital to you as an investor because it lets you comprehensively evaluate the profitability of a potential deal. Thus, it allows you to better understand how an investment may perform, giving you a clear picture as to whether or not you want to invest in the property.
Cash on cash return is also important in that it helps you determine the best method of financing for your investment. For example, by letting you compare using a traditional mortgage or private lender, you can determine which of these would help you maximize your annual returns.
Finally, you can use cash on cash return to compare various types of investment properties. By doing so, you can find out how different properties may work for better or worse in your portfolio. Cash on cash return will make it possible for you to consistently examine the long-term potential of different assets.
How is Cash on Cash Return Calculated?
To calculate cash on cash return for your investments, you use the following formula:
Cash on Cash Return=(Annual Cash Flow/Initial Cash Investment)x100%
To properly calculate your return, it will help if you already have a reasonable idea as to your annual cash flow. This is important, since this allows you to know the rental income left over after you’ve paid various expenses. As for recurring expenses that will impact your calculations, these include:
–Property taxes and insurance
–Property management fees
–HOA fees (if any)
By preparing an itemized list of the rental income you earn and the expenses you pay each month, you’ll know your annual cash flow and thus can calculate your cash on cash return.
Cash on Cash Return Step by Step
When you’re ready to find out your cash on cash return, use the following steps.
First, determine your monthly cash flow by subtracting expenses from income. As an example, if your rental income is $2,000 per month and your monthly expenses, including your mortgage, are $1,500, your monthly cash flow is $500.
Next, multiply this number by 12 to get your annual cash flow, which in this case would be $6,000.
After this, add up your initial cash investments, such as closing costs, down payment, and improvements made to the property. As an example, let’s say your initial cash outlay was $75,000.
To calculate your cash on cash return, divide annual cash flow by initial investment. In this case, you would divide $6,000 by $75,000, which would equal 0.08. By multiplying this fraction by 100%, you arrive at a cash on cash return of 8%, indicating that after one year you will have earned back eight percent of your initial cash investment, which in this case was $75,000.
How is Cash on Cash Return Different from ROI?
First, cash on cash return and ROI are not the same, contrary to what some investors believe. Cash on cash return focuses only on returns as they pertain to the cash you spent out of pocket, while ROI examines the returns on your total investment, which will include financing you used to make the purchase.
Cash on Cash Return and NOI
Along with ROI, cash on cash return also differs from your net operating income, or NOI. The biggest difference is that cash on cash return considers debt services, while NOI does not. To project your NOI, you subtract a property’s operating expenses from the total income the property will earn when it has no vacancies.
What is Considered to be a Good Cash on Cash Return?
Unfortunately, there is no magic number that is considered to be the perfect cash on cash return. Since all investment properties are unique and involve various forms of financing, expenses, and other details, you will have to judge for yourself whether or not your cash on cash return meets with your approval.
As a general rule, most investment experts agree that a cash on cash return in the 5-7 percent range is acceptable, while a return in the 8-12 percent range is considered to be very good. However, remember to take your investment objectives into account when analyzing your numbers. Thus, if you invest in an appreciating market, your return may be lower, yet that will not necessarily point to you making a bad investment.
Check Your Cash on Cash Return Annually
As a final reminder, it is important for you to determine your cash on cash return each year. By doing so, this lets you see how your investment is progressing, how it is impacting your portfolio, and if you are indeed meeting your investment objectives. Since rental prices are always subject to fluctuation, knowing your cash on cash return can help you in making decisions about rent increases or other related matters.
Though you may have to punch a few buttons on your calculator and take some time to determine monthly expenses and other things pertaining to your properties, determining your cash on cash return will benefit your portfolio in more ways than you expected.
For each property MartelTurnkey lists for sale, we provide a cash flow summary which clearly shows the estimated annual Cash on Cash return. If you are financing the property, refer to the “leverage tab” to find this ratio. Our sales team will be happy to discuss these numbers with you. Book a call to learn more.
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