What Is Cash-on-Cash Return In Real Estate And Why Does It Matter?

The cash-on-cash return rate measures cash flow before tax relative to the amount of cash invested in a property investment.

What is Cash-on-Cash Return?

The cash-on-cash return rate, also known as cash yield, measures the amount of cash flow relative to the amount of cash invested in a property investment and is calculated on a pre-tax basis. This is often a favored calculation for real estate investors as it is a reasonably accurate estimate of cash flow.

The cash-on-cash return metric measures only the return for the current period, typically one year, rather than for the life of the investment or project.

Having a good cash-on-cash return rate determines how profitable a property is. This is why it’s deemed one of the more important ROI calculations by real estate investors. It can also be used as a forecasting tool to set a target for projected earnings and expenses.

Related: Tax On Rental Income: How Much Tax Do You Owe?

Key Takeaways

  • Cash-on-cash return assesses the cash flow generated in relation to the initial cash investment in a property venture, calculated before taxes. 
  • Cash-on-cash return evaluates returns for the present period, usually one year, rather than over the entire lifespan of the investment or project. 
  • Cash-on-cash return serves as a predictive tool, aiding in the establishment of projected earnings and expense targets.

How Do You Calculate Cash-on-Cash Return?

To calculate the cash-on-cash return, you need to know your annual cash flow before taxes and the total amount invested. To work out the annual cash flow of the property you need to calculate the total amount of expected income in one year including any additional income from the investment property, and then subtract the operating expenses, annual mortgage payments, and account for any vacancy periods

The formula for calculating cash-on-cash return looks like this:

Cash-on-Cash Return = Net Annual Cash Flow (before tax) / Total Equity Invested

When Annual Cash Flow = Income – Operating Expenses – Vacancy Period – Mortgage Repayments

What’s a Good Cash-on-Cash Return?

Cash-on-cash return is a measurement used by real estate investors to determine a property’s performance. It is a calculation often used for long-term investments as it focuses on cashflow, signifying whether an investment will generate adequate funds for repaying debts.

Although there is no rule of thumb, investors seem to agree that a good cash-on-cash return is between 8 to 12 percent.

Cash-on-cash return example:

Equity Invested

  • The property purchase price was $250,000.
  • The investor has paid a total of $80,000 to date.

Cash flow

  • Monthly rent is $3,000 meaning an annual income of $36,000.
  • 5% vacancy rate means rent loss of $1,800.
  • Operating expenses (including costs such as maintenance, HOA fees legal, and management fees) equal an annual total of $4,200.
  • Mortgage repayments are $7,200 annually.

Making an annual net cash flow of: 36,000 -1,800 – 4,200 – 7,200 = 22800

Cash-on-cash return =  $22,800/ $80,000
= 28.5%

In addition to deriving the current return, the cash-on-cash return can also be used to forecast the expected future cash distributions of an investment. However, it is not a promised return but is instead a target used to assess a potential investment. In this way, the cash-on-cash return is an estimate of what an investor may receive over the life of the investment.

Why is Cash-on-Cash Return Important In Real Estate?

Cash-on-cash return, also known as the cash yield on a property investment, evaluates the performance of a real estate investment and stands as a vital calculation for real estate return on investment (ROI). In essence, this metric offers business owners and investors a straightforward evaluation of a property's business plan and the potential cash distributions throughout the lifetime of the investment.

Related: Cash-on-Cash Return vs Cap Rate for Your Rental Properties

Are Cash-on-Cash Return and ROI the Same?

These terms are sometimes used interchangably, cash-on-cash return and ROI (return on investment) diverge, particularly in real estate transactions involving debt. Many commercial properties utilize debt, causing the actual cash return to deviate from the conventional ROI. 

"ROI encompasses the comprehensive return, incorporating the debt load, whereas cash-on-cash return solely evaluates the return on the invested cash, offering a more precise appraisal of the investment's efficacy." - says Jasen Edwards, chair of the Agent Editor Board at Agent Advice.

Related: Real Estate Investing: Cash on Cash Return vs ROI

What are the Disadvantages of Cash on Cash Return?

Cash-on-cash return has several drawbacks. The metric might inflate the yield when a portion of the distribution comprises a "return of capital (ROC)" instead of a "return on invested capital (ROIC)," which is common with income trusts. But, probably the primary limitation of cash on cash return as a real estate analysis metric is that it doesn’t take taxes into consideration.

Final Words: Cash-on-Cash Return

Understanding the concept of cash-on-cash return is essential if landlords want to gain insight into the performance of their real estate investments. However, knowing the cash-on-cash formula is only part of the puzzle. You also have to have accurate financial records if you want to fully leverage this metric. 

Landlord Studio property management and accounting software offers the ideal solution, with award-winning ease of use and automation features designed specifically for real estate investors, it is the #1 accounting platform for landlords managing small to medium-sized portfolios. 

With over 15 accountant-approved and customizable reports, including an income statement, P&L, rent roll, rent ledger, and a specialized Schedule E report, Landlord Studio streamlines rental accounting tasks, ensuring landlords maintain precise and detailed financial records and can effortlessly generate powerful reports for tax time.

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