Understanding Cash on Cash Return in Real Estate Investing

In the world of real estate investing, the term "cash on cash return" is often tossed around. But what does it really mean? And how can it impact your investment decisions? In this article, we aim to demystify the concept and guide you through its implications in real estate investing.

What is Cash on Cash Return?

Cash on Cash Return is a financial metric used in real estate investing that measures the cash income earned on the cash invested in a property. Essentially, it calculates the return on investment (ROI) based only on the actual cash you have invested, ignoring the impact of any borrowed funds.

Here is the formula for Cash on Cash Return:

Cash on Cash Return = (Net Operating Income / Total Cash Invested) x 100%

This metric is particularly useful in scenarios where the investor has leveraged their investment through a mortgage or other loan, as it considers the actual cash invested rather than the total value of the property.

We discuss leveraging in our article on real estate investing, where you can learn about other strategies and metrics as well.

Why is Cash on Cash Return Important?

Cash on cash return is crucial for real estate investors because it provides an accurate picture of the profitability of an investment property. It also helps in comparing different investment properties to determine which offers the best return on your cash.

This metric becomes particularly important when investing in rental properties. The cash on cash return gives an investor a realistic expectation of the annual income they can expect to receive on the money they've invested.

In the next section, we will discuss how to calculate the cash on cash return and what makes a good cash on cash return.

Calculating Cash on Cash Return

When calculating the cash on cash return, there are two main factors to consider:

1. Net Operating Income (NOI): This is the annual income generated by the property after deducting all operating expenses (excluding mortgage payments).

2. Total Cash Invested: This includes the down payment, closing costs, repair costs, and any other cash expense required to acquire and operate the property.

Again, the formula for cash on cash return is as follows:

Cash on Cash Return = (Net Operating Income / Total Cash Invested) x 100%

Let's look at an example to see how this works in practice:

Say you purchase a rental property for $200,000, putting down 20% ($40,000) and taking out a mortgage for the remaining balance. Your closing costs and immediate repair costs total $10,000, making your total cash invested $50,000.

If the annual rental income from the property is $24,000, and the operating expenses total $4,000 per year, your NOI would be $20,000.

Using the formula above, your cash on cash return would be: (20,000 / 50,000) x 100% = 40%

As you can see from the example, the cash on cash return helps you understand the return on your actual cash investment.

But what exactly is considered a good cash on cash return? Let's explore that next.

What is a Good Cash on Cash Return?

The ideal cash on cash return varies greatly depending on the investor's risk tolerance, investment strategy, and the specific real estate market they are investing in. However, most real estate investors aim for a cash on cash return between 8% and 12%. If you're interested in investing in real estate, it's essential to evaluate the potential cash on cash return alongside other indicators, such as the capitalization rate, to ensure a robust investment decision.

"Success in real estate investing, as with any investment, lies in the numbers. A healthy cash on cash return on a property does not necessarily indicate a good investment on its own. The cash on cash return should be one of many tools used by real estate investors to evaluate potential investment opportunities."

Investing in real estate is complex, and understanding the various financial metrics involved is crucial. To help you on your journey, you can check out our comprehensive guide on real estate investing. Also, take a look at our review of Roofstock, a platform designed to make investing in rental properties more accessible.

In conclusion, cash on cash return is a valuable tool that can help real estate investors assess the profitability of their investments. However, like any investment metric, it shouldn't be used in isolation. By understanding what cash on cash return is, how to calculate it, and how it fits into the broader context of real estate investing, you'll be well-equipped to make savvy investment decisions.

Thanks for reading! If you found this article helpful, don't forget to share it with your network. For more investing tips and financial advice, be sure to check out other articles on The Saving Dude. Happy investing!