Why Successful Real Estate Investors Focus on Cash-on-Cash Return

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.

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.