Cash-on-cash return is an important metric for real estate investors to evaluate the profitability of their investments. It measures the amount of cash flow generated by a property relative to the initial cash investment made. In this article, we’ll explain what cash-on-cash return is, how it’s calculated, and why it’s important for real estate investors.
What is Cash on Cash Return?
Cash-on-cash return is a financial metric used to assess the performance of income generating assets. It is calculated by dividing the annual pre-tax cash flow from an investment property by the total amount of cash invested in that property. This ratio gives investors an idea of how much money they can expect to make on their investment each year before taxes are taken into account.
The importance of cash-on-cash return lies in its ability to quickly and accurately measure the profitability of an investment property without taking into account other factors such as appreciation. By focusing solely on pre-tax cash flow, investors can get a better understanding of how profitable their investments are and make more informed decisions about whether or not to invest in a particular property.
Calculation of Cash-on-Cash Return
The formula for calculating cash-on-cash return is:
Cash Flow Before Taxes / Total Cash Invested = Cash-on-Cash Return
For example, if you invest $100,000 in a rental property and generate $10,000 in pre-tax cash flow each year, then your cash on cash return would be 10%.
It is important to know the actual cash invested when calculating this metric, as it can vary depending on the down payment, mortgage payments, and operating expenses associated with each property.
Knowing your annual pre-tax cash flow is essential for accurately calculating your cash-on-cash return. This figure can be determined by subtracting all operating expenses from rental income received from tenants or other sources. Once you have this number, you can divide it by your total cash invested in order to calculate your rate of return on that particular investment property.
Advantages of Using Cash-on-Cash Return to Evaluate Real Estate Investments
One of the main advantages of using cash-on-cash return as a measure of investment performance is its simplicity. Unlike other metrics such as ROI (return on investment) or cap rate (capitalization rate), cash-on-cash return does not require complex calculations or assumptions about future performance. This makes it easier for investors to quickly compare different properties and make informed decisions about their investments.
Comparison of Cash-on-Cash Return with Other Investment Metrics (ROI, Cap Rate, etc.)
While cash-on-cash return is a useful tool for evaluating real estate investments, it should not be used in isolation. Other metrics such as ROI (return on investment) and cap rate (capitalization rate) provide additional information that can help investors make better decisions about their investments.
For example, ROI measures the total return on an investment over time, while cap rate measures the potential yield from an income producing asset relative to its market value. Both metrics provide valuable insights into an investment’s potential returns that are not captured by cash-on-cash return alone.
Importance of Understanding the Local Market, Rental Prices, and Other Factors When Evaluating Real Estate Investments
When evaluating real estate investments, it is important for investors to understand the local market conditions and rental prices in order to accurately assess potential returns from an investment property. Factors such as vacancy rates and tenant turnover can have a significant impact on an investor’s ability to generate positive cash flows from their investments over time.
By understanding these factors and taking them into account when evaluating real estate investments, investors can ensure that they are making informed decisions about their investments and maximizing their returns in the long run.
Understanding the Limitations and Considerations of Cash-on-Cash Return
When using this metric, investors should be aware of its limitations and consider other factors when evaluating real estate investments. For example, cash-on-cash return does not take into account the appreciation or depreciation of an asset over time, so it should be supplemented with other metrics such as return on investment (ROI) when evaluating long-term performance.
Conclusion
Overall, cash-on-cash return is a useful tool for assessing potential real estate investments and is an important metric for investors to understand in order to maximize their returns. By taking into account all the relevant factors when evaluating properties, investors can ensure that they are making informed decisions about their investments and maximizing their returns in the long run.
