Cash on cash return is a simple and effective metric for real estate investors to gauge the profitability of an investment property. Understanding how to calculate cash on cash return it can help you assess your investments and make more strategic decisions. This guide will break down the process step by step, ensuring you can calculate cash on cash return with ease.
What is Cash on Cash Return?
Cash on cash return is the percentage of your invested cash that you earn back annually through the income from a property. Unlike other return metrics, it focuses solely on the cash investment and excludes variables like appreciation or tax benefits. It’s an essential tool for investors who want a clear snapshot of their property’s cash flow performance relative to their initial cash investment.
Why Calculate Cash on Cash Return?
Understanding cash on cash return helps investors evaluate the profitability of their real estate investments. It allows you to compare potential investments and assess whether they align with your financial goals. With accurate calculations, investors can avoid overestimating potential returns and focus on opportunities that provide consistent cash flow.
Step-by-Step Guide to Calculating Cash on Cash Return
Step 1: Determine the Annual Pre-Tax Cash Flow
The first step in your calculation is to determine the annual pre-tax cash flow from the property. This is the income you’ll earn from rents after covering all operating expenses but before accounting for taxes. To calculate this, follow these steps:
- Add up all the annual rent received from tenants.
- Subtract annual operating expenses, such as property management fees, maintenance costs, and insurance premiums.
For example, if you earn $50,000 annually from rents and your operating expenses total $20,000, your pre-tax cash flow would be $30,000.
Step 2: Account for Initial Cash Investment
Next, identify the amount of cash you’ve invested in the property. This includes your down payment, closing costs, and any other out-of-pocket expenses incurred during the purchase process.
As an example, if you made a $100,000 down payment and spent $5,000 on closing costs, your total cash investment would be $105,000.
Step 3: Use the Cash on Cash Return Formula
Once you have your pre-tax cash flow and the initial cash investment, plug these numbers into the cash on cash return formula:
Cash on Cash Return = (Annual Pre-Tax Cash Flow ÷ Total Cash Investment) × 100
Using the earlier examples:
Cash on Cash Return = ($30,000 ÷ $105,000) × 100 = 28.57%
This result means that you are earning a 28.57% return on your cash investment each year.
Benefits of Cash on Cash Return
- Simplicity: Compared to other analytics, cash on cash return is easy to calculate and interpret.
- Real-Time Results: This metric provides a clear, immediate picture of a property’s ability to generate cash flow.
- Direct Comparison: It helps compare various investment properties at a glance, making investing decisions easier.
- Focus on Cash Flow: It allows investors to hone in on the tangible income their properties generate, helping them prioritize properties with strong returns.
Make Smarter Investment Decisions
By understanding how to calculate cash on cash return, you can better assess the income potential of your real estate investment opportunities. Applying this method will guide you in making informed decisions that align with your financial objectives.