Similar to ROI or return on investment, cash-on-cash return measures the percentage of cash flow that's returned to the investor after [glossary_exclude]accounting [/glossary_exclude]for all operating expenses.
CCR is a good metric to use when considering real estate investments because it focuses on the cash that's being generated by the property, rather than simply its overall value.
In the real estate industry, cash-on-cash return is usually expressed as a percentage and can be a great way to compare different properties.
What is Cash on Cash Return
The cash-on-cash return measures the amount of money earned each year from the total sum invested. This figure is pre-tax and takes into account annual cash flow.
In simple words, the cash-on-cash return is what an investor earns on investment, taking into consideration the cash flow and not simply the overall value of the property.
CCR is similar to ROI but is a more accurate cash flow metric. It's mostly used in commercial real estate and by experienced investors. It can also be used as an addition to ROI because it's a good indicator of what an investment will return in cash.
How to Calculate Cash on Cash Return
Calculating CCR is straightforward. There are mainly two elements that go into it: Annual pre-tax cash flow and Total cash invested.
The annual cash flow is calculated by
Annual rent – Mortgage payments
The formula is
CCR = Annual pre-tax cash flow / Total cash invested
Where
Annual pre-tax cash flow: This is the amount of money you bring in each year from the property after expenses, but before taxes.
Total cash invested: This is the total amount of your own money that you put into the deal. It includes the down payment, closing costs, and any rehab or renovations that need to be done.
Examples
Let's say you're looking at a duplex that you plan to buy for $200,000. You put down $40,000 and finance the rest. The property is expected to generate $24,000 in annual rent. Your total cash investment would be $40,000 + closing costs + any renovations necessary.
After one year the annual pre-tax cash flow would be $24,000 - $14,400 (12 months x $1,200 monthly mortgage payment). This gives you a cash-on-cash return of
$24,000 - $14,400/$40,000 = 0.60 or 60%.
This means that for every dollar you put in, you're getting 60 cents back in cash flow.
To compare, if the property went up 10% in value after one year, your return on investment would be
($22,000/$200,000) x 100% = 11%.
While an ROI of 11% is great, it's not as good as a CCR of 60%.
This is because the CCR takes into account the cash that you have in hand, while the ROI only considers the increase in value of the property.
Conclusion
Cash-on-cash return is a helpful metric for real estate investors because it measures the actual cash flow of an investment, rather than just its overall value. It can be a good complement to ROI because it helps you see what an investment will return in cash.
Article Source Here: Cash on Cash Return: Definition, Calculation, Formula, Example, Equation
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