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What Is Cash-on-Cash Return?
The cash-on-cash return is a straightforward metric used to measure the annual return on cash invested in real estate properties, particularly commercial ones. Unlike standard ROI, it focuses solely on the cash invested, thus offering a clearer insight into an investment’s performance, especially when properties involve long-term debt. This calculation is pivotal in assessing potential cash distributions and understanding the effectiveness of a property investment strategy.
Key Takeaways
- Cash-on-cash return measures the annual return on the cash invested in a property, offering a straightforward evaluation of real estate investments.
- It is particularly useful for assessing the performance of properties involving long-term debt, as it focuses on cash flow rather than total ROI.
- The metric calculates returns based on pre-tax cash inflows and outflows, providing clarity on the actual cash yield from the investment.
- An example demonstrates how cash-on-cash return is calculated by dividing the net cash flow by the total cash invested, illustrating its practical application in real estate.
- While cash-on-cash return is a valuable tool, it does not account for the full debt burden, unlike the traditional ROI metric.
How Cash-on-Cash Return Impacts Real Estate Investments
A cash-on-cash return is a metric normally used to measure commercial real estate investment performance. It is sometimes referred to as the cash yield on a property investment. The cash-on-cash return rate provides business owners and investors with an analysis of the business plan for a property and the potential cash distributions over the life of the investment.
Cash-on-cash return analysis is often used for investment properties that involve long-term debt borrowing. When debt is included in a real estate transaction, as is the case with most commercial properties, the actual cash return on the investment differs from the standard return on investment (ROI).
Calculations based on standard ROI take into account the total return on an investment. Cash-on-cash return, on the other hand, only measures the return on the actual cash invested, providing a more accurate analysis of the investment’s performance.
The formula for cash-on-cash return is:
Cash on Cash Return
=
Annual Pre-Tax Cash Flow
Total Cash Invested
where:
APTCF = (GSR + OI) – (V + OE + AMP)
GSR = Gross scheduled rent
OI = Other income
V = Vacancy
OE = Operating expenses
AMP = Annual mortgage payments
\begin{aligned} &\text{Cash on Cash Return}=\frac{\text{Annual Pre-Tax Cash Flow}}{\text{Total Cash Invested}}\\ &\textbf{where:}\\ &\text{APTCF = (GSR + OI) – (V + OE + AMP)}\\ &\text{GSR = Gross scheduled rent}\\ &\text{OI = Other income}\\ &\text{V = Vacancy}\\ &\text{OE = Operating expenses}\\ &\text{AMP = Annual mortgage payments}\\ \end{aligned}
Cash on Cash Return=Total Cash InvestedAnnual Pre-Tax Cash Flowwhere:APTCF = (GSR + OI) – (V + OE + AMP)GSR = Gross scheduled rentOI = Other incomeV = VacancyOE = Operating expensesAMP = Annual mortgage payments
Real-World Example of Cash-on-Cash Return
Cash-on-cash return considers the property’s pre-tax cash inflows and outflows. For example, suppose a commercial real estate investor invests in a piece of property that does not produce monthly income.
The total purchase price of the property is $1 million. The investor pays $100,000 cash as a down payment and borrows $900,000 from a bank. Due are closing fees, insurance premiums, and maintenance costs of $10,000, which the investor also pays out of pocket.
After one year, the investor has paid $25,000 in loan payments, of which $5,000 is a principal repayment. The investor decides to sell the property for $1.1 million after one year. This results in a total cash outflow of $135,000, and after repaying the debt of $895,000, the cash inflow is $205,000. The investor’s cash-on-cash return is ($205,000 – $135,000) ÷ $135,000 = 51.9%.
In addition to deriving the current return, the cash-on-cash return can also be used to forecast the expected future cash distributions of an investment. However, unlike a monthly coupon payment distribution, it is not a promised return but is instead a target used to assess a potential investment. In this way, the cash-on-cash return is an estimate of what an investor may receive over the life of the investment.
What Does Cash-on-Cash Return Tell You?
Cash-on-cash return, sometimes referred to as the cash yield on a property investment, measures commercial real estate investment performance and is one of the most important real estate ROI calculations. Essentially, this metric provides business owners and investors with an easy-to-understand analysis of the business plan for a property and the potential cash distributions over the life of the investment.
Are Cash-on-Cash Return and ROI Identical?
Though they are often used interchangeably, cash-on-cash return and ROI (return on investment) are not the same when debt is used in a real estate transaction. Commercial properties usually involve debt, which means the cash return on investment differs from the standard ROI. ROI calculates the total return on an investment, including the debt burden. In contrast, cash-on-cash return measures only the return on the actual cash invested, offering a more precise analysis of investment performance.
How Is Cash-on-Cash Return Calculated?
Cash-on-cash returns are calculated using an investment property’s pre-tax cash inflows received by the investor and the pre-tax outflows paid by the investor. Essentially, it divides the net cash flow by the total cash invested.
For example, an investor purchases a property for $1 million, putting $100,000 cash as a down payment and borrowing $900,000. The investor also pays $10,000 cash for ancillary costs out of pocket. The investor decides to sell the property for $1.1 million after having paid $25,000 in loan payments that include a principal repayment of $5,000.
This means the investor’s total cash outflow is $135,000 [$100,000+$10,000+$25000] and cash inflow is $205,000 [$1,100,000 – $895,000]. So, the investor’s cash-on-cash return is 51.85% [($205,000 – $135,000) ÷ $135,000].
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