How Cash-on-Cash Return Works in Real Estate

Cash-on-cash return, also referred to as a property investment’s cash yield, compares the earnings on an investment to the pre-tax cash investment, or mortgage payment, for a set period. Knowing this value helps you assess an investment's cash flow. These numbers do not include any debt taken on from a lender and are not impacted by interest rates or tax obligations.

To calculate a property’s cash-on-cash return, first calculate its annual pre-tax cash flow or net cash flow.

1. 1. Begin by calculating your net operating income (NOI). To calculate your net operating income, find your gross rental income (the maximum you would receive if the rental property was occupied for the full year) and add any additional property income, such as non-refundable deposits or parking fees.
2. 2. Next, subtract your financing costs. Investment property financing costs include expenses, such as operating expenses, annual debt service (mortgage payment minus insurance and taxes), and vacancy losses—calculate the income lost from actual vacancy by multiplying days vacant with the daily rental rate; if the property is new, you can use potential vacancy and estimate your expected losses. The number you come up with here is your annual pre-tax cash flow.
3. 3. Then, calculate your total cash invested. This number includes your down payment, financing and closing costs, holding and carry costs (any expenses before the property is rented), and repairs and maintenance.
4. 4. Plug these numbers into the cash-on-cash return formula: Cash-on-Cash Return = (Annual Pre-tax Cash Flow / Total Cash Invested) x 100. The final number will be your percentage cash-on-cash return.

Cash-on-cash return is a useful tool in several investment applications. The simplicity of the cash return formula makes it an easy metric when trying to decide which of multiple properties is the best potential investment. It can aid in assessing your financing options by providing a rough estimate of each option's impact on your bottom line.

It's especially helpful in assessing commercial real estate. The high debt that is often carried with these investments makes this an ideal calculation as it excludes this debt. Finally, the cash-on-cash return metric is a good starting point for new investors who may need time to understand some of the more sophisticated measures, such as internal rate of return (IRR).

Let's say you decide to purchase a fourplex for a purchase price of $2,000,000 and you have $400,000 to offer as a down payment. The remaining $1,600,000 is being financed by the bank. It will take an additional $35,000 to close and you will need to invest another $15,000 to improve the property.

Suppose you will rent each unit for $1700 per month, creating an annual revenue of $81,600. Your monthly payments, excluding taxes and insurance, are $3,200, giving you an annual expense of $38,400.

In this scenario, your net operating income is $81,600. To determine your annual pre-tax cash flow, you must subtract your recurring expenses, the $38,400 from your NOI. This leaves you with $43,200.

• Net Operating Income - Expenses = Annual Pre-Tax Cash Flow
• $81,600 - $38,400 = $43,200

Now you must add up the total amount of cash invested, which includes your $400,000 down payment, $35,000 closing costs, and $15,000 improvement fees. This brings your cash investment to $450,000. Plug those numbers into the cash-on-cash return formula.

• Annual Pre-tax Cash Flow / Total Cash Invested = Cash-on-Cash Return
• $43,200 / $450,000 = 0.096 = 9.6%

For this property, you can expect a 9.6% cash-on-cash return in the first year.

Cash-on-cash return and return on investment (ROI) each measure your investment property's profitability but do so in different ways. Whereas cash-on-cash return is your annual pre-tax cash flow divided by your total cash invested, return in investment is your net profit divided by your total costs.

Cash-on-cash return measures only the actual cash invested and earned from a property. This ignores profitability influencers like depreciation, tax benefits, and cost of the mortgage over the life of the loan. This makes COC return a great choice to measure expectations for the first annual return of new commercial properties or to compare investment opportunities in a hot real estate market.

ROI, on the other hand, gives the total return and is a better indicator of overall investment performance. It is the more suitable metric to use when you want to test the profitability of an investment over an extended period. To simplify this comparison, cash-on-cash return is a snapshot of investment performance, while ROI is the investment's life story to date.

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