Glossary for Investors

Cash on Cash Return

Cash on cash return — also referred to variously as cash-on-cash return, cash in cash return, cash over cash return, or cash to cash return — is a metric that measures the annual pre-tax cash flow from a property relative to the initial equity investment. This return provides a snapshot of the income generated from the invested capital before taxes, offering a glimpse into the investment’s performance over a specific period, usually one year.

The formula for calculating cash on cash return is simple but very prominent in real estate investing. It is calculated by dividing the annual pre-tax cash flow by the invested equity. The formula is:

Cash on Cash Return (%) = Annual Pre-Tax Cash Flow ÷ Invested Equity

This metric is particularly insightful as it considers the effects of financing costs, such as mortgage payments, offering a leveraged perspective on the investment’s yield.

For example, consider an investor who purchases a rental property for $500,000 with a down payment of $100,000 and secures a mortgage for the remaining $400,000. If the property generates $60,000 in annual rental income and incurs $20,000 in expenses (excluding mortgage payments), the annual pre-tax cash flow would be $40,000. The cash on cash return would be:

Cash on Cash Return (%) = $40,000 (Annual Pre-Tax Cash Flow) ÷ $100,000 (Invested Equity) = 40%

This 40% cash on cash return indicates a high yield on the investor’s initial equity, significantly influenced by the leverage of the mortgage.

A Comparative Perspective

When evaluating real estate opportunities, it’s crucial to distinguish cash on cash return from other metrics like cap rate and return on investment (ROI). Cap rate provides an unlevered view by excluding financing costs and is calculated by dividing the property’s net operating income (NOI) by its current market value. ROI, however, includes both the cash flow and capital gains from the property, offering a comprehensive view of the investment’s performance over the entire holding period, including the eventual sale of the property.

cash on cash returns can be attractive for fixed-rate real estate

Cash on cash return from Earn investments on the EquityMultiple platform can be attractive to self-directed investors, and are typically contractually obligated.

What Constitutes a Good Cash on Cash Return?

A good cash on cash return is subjective and varies based on market conditions, property types, and geographic locations. Generally, a return between 6% and 10% is considered attractive in the real estate market. However, in 2024 and looking ahead in present market conditions, some investors aim for even higher percentages, seeking cash on cash returns of 10% or more as a benchmark for a great investment. It’s important for investors to consider these factors alongside their risk tolerance and investment goals to determine their ideal return threshold.

For instance, a property in a high-demand urban area might offer a lower cash on cash return due to higher property prices but could provide greater stability and potential for appreciation. On the other hand, a property in an emerging market might offer a higher cash on cash return but come with increased risk and volatility.

FAQs on Cash on Cash Return

Q: Why is cash on cash return important in real estate investing? A: Cash on cash return is crucial because it measures the annual income an investment generates relative to the amount of cash invested, providing a clear picture of an investment’s performance and helping investors make informed decisions.

Q: How does cash on cash return differ from cap rate? A: Cash on cash return includes the effects of financing and provides a levered perspective, while the cap rate offers an unlevered view by excluding financing costs, focusing on the property’s inherent income-generating potential.

Q: Can cash on cash return predict the future performance of a real estate investment? A: While cash on cash return offers insight into the current performance of an investment, it does not account for future appreciation, depreciation, or tax implications, and should be used alongside other metrics for comprehensive analysis.

Q: How does leverage affect cash on cash return? A: Leverage can amplify cash on cash return by allowing investors to control a larger asset with a smaller equity investment. However, increased leverage also introduces higher risk, which must be carefully managed.

Q: What factors should I consider when evaluating a good cash on cash return? A: Investors should consider market conditions, property types, location, risk tolerance, and personal investment goals when evaluating what constitutes a good cash on cash return for their portfolio.

Full Glossary