What is Cash on Cash Return?
The cash-on-cash return metric is a calculation of the amount of income an investor earns on an apartment property in comparison to the amount of cash invested. Cash on cash return is sometimes referred to as the equity dividend rate, and this calculation is used as a standard for assessing a possible apartment property investment. Generally speaking, when it comes to the cash on cash return metric, the figure is most impacted by the leverage of a given transaction, since leverage dictates the amount of upfront cash an investor is required to put down in order to enter into a commercial real estate investment (higher leverage meaning the investor can buy more with less money).
Calculating Cash on Cash Return
Cash-on-Cash Return Calculator
Cash on cash return can be calculated by using the following formula:
Cash on Cash Return Formula
Cash on Cash Return= Annual Dollar Income / Total Dollars Invested
In order to calculate the cash on cash return, an investor must first determine the net income of the target property for the year. The net income can be determined by taking the gross income that the property generated and then subtracting any operating costs (and in the event the building was financed with an apartment loan, debt service as well). Then, the net income should be divided by the total cash amount spent on the property. The resulting figure is then converted to a percentage representing the cash on cash return.
The cash on cash return metric can vary greatly for the same apartment property depending on the financial aspects of how that property was acquired. For example, if an investor spends $3 million buying a piece of property, their cash on cash return will be far lower than if they borrow $2.5 million and only spend their cash on a $500,000 down payment and closing costs.
Understanding the Cash-on-Cash Return Formula and Calculator
In order to properly calculate cash on cash return, an investor needs to know two basic figures. The figures important to the cash on cash return formula are the investor’s cash investment and the annual income. An investor will need to calculate the expected first year of annual income prior to using the cash on cash return calc, this should include rental income, parking, other due payments, etc. Once that figure is established, then the costs of the investment are to be calculated. Some items to consider for this figure are:
- Interest on the loan
- Down payment
- Closing costs
- Repair / rehabilitation costs
- Bank loan costs
- Seller concessions- Including, but not limited to: utilities, property taxes, insurance, etc. and any other additional costs during the vacancy period.
Once all of these figures have been ascertained, then using the cash on cash return calculator is as simple as plugging in the right figures where asked.
Using Cash on Cash Return
Calculating cash-on-cash return is incredibly useful to any real estate investor. The formula was designed to help evaluate the profitability of a potential investment. The calculator further makes the comparison between potential multifamily investments more straightforward. Utilizing the calculator should also help investors assess the possible return on different types of investment properties.
Understanding and being able to determine cash on cash returns is invaluable, but the calculation itself does have some limitations. For instance, getting an accurate cash on cash return figure for a rental property undergoing extensive repairs over many months can prove to be an extremely difficult feat, if not impossible. In addition, payments such as down payments, closing costs, and even compensating contractors tend to be made at different times throughout the acquisition and ownership of an apartment property.
There are other potential variables that can affect the cash-on-cash return which include:
- Investor’s personal tax situation
- Appreciation or depreciation of the property
- Associated risk with the rental property
Cash-on-Cash Return (CoC) vs. Return on Investment (ROI)
The difference between cash-on-cash return (CoC) and return on investment is the inclusion of debt. Cash on cash return exclusively examines the profits relative to the paid investment costs. The return on investment (ROI) calculation takes into account loans, appreciation, tax benefits, and many more variables, so it loses its relevance for the purposes of comparing apartment property investment because it accounts for all of the money invested, including debt to be paid.