A Guide To Cash-On-Cash Return
In real estate spaces, you’ll often hear the names of quite a few metrics thrown around. There’s ROI, NOI, IRR, GRM, LTV, cap rate, CoC, and many others.
These metrics are an important way to evaluate the performance of a current or future property. But if you’re not a fan of alphabet soup or are generally unfamiliar with how to calculate evaluative metrics for your properties, you may struggle to follow along with the formulas.
In this article, we’ll break down one metric: Cash-on-cash (or CoC) return. We’ll explain how to calculate it with an example, discuss what a good CoC return looks like, and mention some complications to watch out for.
What is Rental Property Cash on Cash Return?
Generally speaking, cash on cash (CoC) return is the ratio of what you earn to what you originally invested. When we’re talking about rental property cash on cash return, it’s the amount of money you earn from a property compared to the initial capital you invested in it.
It’s important to note that CoC return differs from ROI (return on investment). ROI is the rate of return on the total money you invested in a property, while CoC is the actual return of cash you invested (also known as equity).
Why Calculate Cash on Cash Return?
Cash on cash return can serve as a reference point for how well your rental property is performing (or will perform in the future). It helps investors make informed decisions and pick the most financially promising property out of tens or hundreds of options.
However, remember that no one metric should be treated as the end-all-be-all for an investment decision. Always use more than one metric when evaluating a potential investment opportunity. For example, after you calculate cash on cash return, it’s a good idea to consider it in coordination with your property’s ROI and capitalization rate. Each of these metrics will give you a prediction or evaluation of your property’s performance from a slightly different perspective.
How to Calculate Cash on Cash Return
Understanding how to calculate cash on cash return will only take a minute of your time, since the formula is very simple:
𝐶𝑎𝑠ℎ 𝑜𝑛 𝐶𝑎𝑠ℎ 𝑅𝑒𝑡𝑢𝑟𝑛=Pre Tax Annual Cash Flow/Total Investment Amount
Let’s use an example to illustrate how this formula works, step by step.
Imagine you just bought a single-family home worth $150,000. Here are the details of the sale:
- Down payment: $30,000
- Closing costs: $4,500
- Monthly mortgage payment: $500
- Initial repairs and renovations: $750
- Rental income: $1,350 per month
- Operating expenses: $600 per month
Now that we have all the details, let’s use the formula above to calculate your cash on cash return for this property.
Step 1: Find the Pre-Tax Monthly Cash Flow
Pre-tax monthly cash flow is calculated by subtracting your monthly operating expenses and mortgage payment from your monthly income.
𝑀𝑜𝑛𝑡ℎ𝑙𝑦 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤=Monthly Income−(Monthly Operating Expenses+ Monthly Mortgage Payment)
𝑀𝑜𝑛𝑡ℎ𝑙𝑦 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤=$1,350−($600+$500)
𝑀𝑜𝑛𝑡ℎ𝑙𝑦 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤=$1,350−($1,100)
𝑀𝑜𝑛𝑡ℎ𝑙𝑦 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤=$250
Step 2: Multiply the Monthly Cash Flow by 12 to Calculate the Pre-Tax Annual Cash Flow
Now multiply your result from Step 1 by 12 to find your annual cash flow:
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤=$250∗12
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤=$3,000
Now you have the top part of the cash-on-cash return formula, the pre-tax annual cash flow.
Step 3: Add Up the Total Investment Amount
Next, we’ll calculate the bottom part of the formula, the total investment amount. This includes all cash expenses related to the property, including the down payment, closing costs, and any repairs or renovations you completed before putting the property in service.
𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝐴𝑚𝑜𝑢𝑛𝑡=Down Payment+Closing Costs+Initial Repairs or Renovations
𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝐴𝑚𝑜𝑢𝑛𝑡=$30,000+$4,500+$750
𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝐴𝑚𝑜𝑢𝑛𝑡=$35,250
Step 4: Calculate Cash-on-Cash Return
All we have to do now is plug our numbers from above into the cash-on-cash return formula:
𝐶𝑎𝑠ℎ 𝑜𝑛 𝐶𝑎𝑠ℎ 𝑅𝑒𝑡𝑢𝑟𝑛= Pre Tax Annual Cash Flow/Total Investment Amount
𝐶𝑎𝑠ℎ 𝑜𝑛 𝐶𝑎𝑠ℎ 𝑅𝑒𝑡𝑢𝑟𝑛=$3,000$35,250
𝐶𝑎𝑠ℎ 𝑜𝑛 𝐶𝑎𝑠ℎ 𝑅𝑒𝑡𝑢𝑟𝑛=.085 or 8.5%
Your cash-on-cash return for this property is about 8.5%.
What is Good Cash on Cash Return?
You might be wondering, “But what does 8.5% cash-on-cash return mean?” Let’s interpret this result and discuss what is good cash on cash return for a rental property.
A cash-on-cash return of 8.5% means that after one year of owning and renting out your property, you will have recovered about 8.5% of the capital you originally invested. After five years, you’ll have recovered just under half of your investment (~43%). And after about twelve years, your property will have generated enough income to recover the entirety of your original investment.
A common range of reference for what makes “good” cash-on-cash return is about 8-12%. Properties with a cash-on-cash return in this range generally make strong investments. However, it’s important to recognize that a property with a CoC return of 4% might still make a great investment, while one with 14% could be a terrible one. Why? The factors this formula considers aren’t the only ones at play.
Complicating Cash-On-Cash Return
As you know, real estate is hardly a risk-free endeavor. There are so many other factors that contribute to a property’s success in the rental marketplace. Plus, it isn’t even guaranteed that the factors our CoC return formula does consider will remain constant over the years. Your income and expenses could change at any point, for any number of reasons.
So, what else could make your cash-on-cash return estimate less accurate?
- Unexpected expenses. There are endless things that could go wrong in a real estate deal: unexpected repairs, increasing property tax rates, evictions, legal liability, etc. Any of these unexpected expenses will impact your cash flow and therefore the entire CoC return formula.
- Unexpected vacancies. The CoC return formula provided above assumes that your property is occupied by a rent-paying tenant all year long. If it isn’t and you have a vacancy for even one month (or worse, your tenant stops paying rent), your CoC return will decrease.
- Inflation. Few real estate evaluation metrics consider the impact of inflation on your rental properties. As the value of money decreases over time, you’re forced to generate more income to maintain the same value.
- Taxes. You probably noticed that the CoC return formula uses pre-tax values. That’s because every investor’s tax situation is different, so using after-tax values would result in a formula that doesn’t accurately represent the potential of a property. Two investors purchasing the exact same property could have the same CoC return, but they might have very different results with the property if they are in different tax brackets.
- Equity. CoC return doesn’t account for the equity added from the principal of your loan payment – instead, it considers the entire mortgage as an expense.
- Appreciation. CoC return also doesn’t account for appreciation, or the fact that the value of your property will naturally increase over time.
- Risks and Opportunity Costs. These are rather difficult to pin down and vary for each investor and property, depending on location, age, condition, and other factors of the property.
- Major Renovations. Not every deal or investor works the same way. For example, if you’re planning major renovations to force appreciation or increase your property’s value and rental rate and you try to calculate CoC based on the formula above, you would be extremely discouraged. However, your CoC return will of course change drastically when your property is reappraised and its new value is accounted for.
When to Use Cash on Cash Return
Due to the limitations of CoC return mentioned above, it’s best to use this metric smartly. Here are some ideal situations or times to use the CoC return formula:
- During the first few years of owning a property – You can use CoC return to measure performance after one or two years of owning and renting out your property. After that, your cash invested will change more as you pay down the loan, and other factors and risks will also come into play more.
- As a quick analysis or comparison method – When you’re dealing with hundreds of deals every day or every week, you don’t have time to analyze every detail. CoC return is a quick way to decide whether to put a property you’ve found into the ‘won’t work’ or ‘worth investigating further’ pile. Once you’ve done an initial sort, you can revisit the most promising deals for further analysis.
- For buy-and-hold investors – Buy-and-hold investors use cash-on-cash return often, since their whole strategy is to rent out properties over the long term instead of selling them.
Conclusion
Cash-on-cash return might be a buzz word in real estate communities, but it’s worth understanding from an evaluative perspective. As long as you remember to consider multiple perspectives and never rely solely on one metric, you can add CoC return to your toolbox of analysis methods that will help you choose a highly successful property.
