Cash on cash return vs ROI: two key metrics real estate investors need to understand when analyzing potential real estate investments.
It takes more than just finding and buying property to be successful as a real estate investor. The goal of real estate investing is to make money. As such, you need to be able to identify those properties which are going to generate the most income and give you the best return on investment. One of the very first things that you need to research and understand is how to analyze potential deals, and what metrics to use to identify the best property to hit your financial goals.
Making money in real estate requires a clear understanding of the differences between cash on cash return and ROI as analytical metrics of investment properties. Understanding the pros and cons of each will help you get the most out of your real estate investments.
Cash on cash return, also sometimes referred to as the cash yield is the measurement of actual cash earned from actual cash invested in a property. This metric can be used to measure the performance of commercial real estate and residential rentals.
Cash on cash return can provide you with a more accurate analysis of your investment properties day to day performance than ROI.
The return on investment is a profitability ratio. It measures how much profit is made from an investment as a percentage of the total cost of the investment.
When we talk about ROI, we’re taking into account the entirety of the cost of an investment property which can help investors understand how a property is performing.
Whilst the two metrics measure similar aspects of a property’s profitability they require different formulas to calculate.
Cash on Cash Return= (Annual Pre-Tax Cash Flow/ Actual Cash Invested) x 100%
The formula for cash on cash return is reasonably simple, you divide the net cash flow of an investment property for a year by the cash that was invested in the property.
To calculate the annual pre-tax cash flow you subtract your annual mortgage payment from your net operating income (NOI). Net operating income is the total income from the property minus the total expenses of the property.
ROI= Net Profit/ Total Cost
To calculate ROI, you need to divide the net profits by the total costs. Unlike cash on cash return. This allows you to calculate the gain on an investment.
Both of these metrics measure a percentage return of a property investment’s profitability. Using these real estate investors can gain a greater understanding of the potential return or stability of an investment.
Generally speaking, cash on cash return is a better representation of investments stability. Whilst ROI is a better representation of ongoing profitability. I really the property you are analyzing will offer high cash on cash return as this signifies that it will pay for itself over the long term, making it a sustainable and stable investment.
ROI as we mentioned is a better measure of the total wealth and profitability and investment creates.
When thinking about which metric to use, the answer generally, is both. The two metrics play a crucial role in the analysis of an investment property. They each represent different factors and both are important for determining the long-term success, sustainability, and profitability of an investment.
Cash on cash return measures how much cash investment property will actually generate whereas ROI measures total wealth that will be created.