Learn about how cash on cash returns are used when looking for investment opportunities in real estate and beyond.
Cash on cash return is a financial metric that measures the annual pre-tax cash flow that a particular investment generates relative to the amount of cash invested. It is often expressed as a percentage.
It's particularly useful for evaluating income-generating properties, such as rental properties, and for comparing investments that require different amounts of cash investment.
The formula for calculating cash on cash return is:
Cash on Cash Return = (Annual Pre-Tax Cash Flow / Total Cash Invested) x 100
Let's say you invest $100,000 in a rental property and receive an annual pre-tax cash flow of $10,000. Your cash on cash return would be:
Cash on Cash Return = ($10,000 / $100,000) x 100 = 10%
A good Cash on Cash Return varies depending on several factors, including the type of property, the location, the investor's risk tolerance, and market conditions. In general, a higher CoC return is more desirable, as it indicates a better return on the invested capital.
As a rough guideline, many real estate investors consider a CoC return of 8-12% to be a good benchmark. However, this range may not be universally applicable, and investors should consider their specific investment goals and risk tolerance when evaluating CoC returns.
Cash on cash return is an essential metric because it helps investors understand the actual cash flow an investment generates. It provides a clear picture of the investment's performance, allowing investors to make informed decisions based on their financial goals and risk tolerance.
ROI is a broader metric that considers the total return on an investment, including both cash flow and capital appreciation. While cash on cash return focuses solely on cash flow, ROI provides a more comprehensive view of investment performance.
IRR is a more sophisticated metric that considers the time value of money and projects the annualized rate of return over the entire investment horizon. Unlike cash on cash return, IRR accounts for the timing and magnitude of cash flows, making it a more accurate measure of investment performance. However, effective on-the-fly calculation of IRR can be impractical for many investors.
Cap rate is a real estate-specific metric that compares the annual net operating income (NOI) to the property's purchase price. It is useful for evaluating the potential return on a property, but it does not consider the financing structure or cash flow, unlike cash on cash return.
In residential real estate, cash on cash return helps investors determine if a property will generate sufficient rental income to cover mortgage payments, taxes, and other operating expenses. It can be a useful tool for identifying profitable rental properties and making sound investment decisions.
Commercial real estate investors also use cash on cash return to evaluate potential investments. It can help them compare different properties based on their cash flow potential and overall investment performance.
While cash on cash return is primarily associated with real estate investing, it can also be applied to other investment types, such as stocks and bonds. In these cases, the metric can help investors understand the cash flow generated by their investments relative to the initial cash outlay.
Cash on cash return is a valuable metric for investors, particularly in the real estate sector. It helps investors evaluate the cash flow generated by an investment and make informed decisions based on their financial goals and risk tolerance. By understanding cash on cash return and its limitations, investors can better navigate the world of investing and optimize their investment strategies.