A cash-on-cash return is a rate that gets used in real estate investments most often. It calculates the cash income earned from the amount of money invested in the property. You’re receiving a figure that’s based on the annual return the investor makes in relation to the amount paid in monthly mortgage obligations.
It’s one of the most uncomplicated calculations to understand and serves as an essential real estate ROI consideration. This will be especially relevant to you if you are younger and looking to spend some of your free cash.
What Does This Information Tell You?
The cash-on-cash return is a metric for commercial real estate investment performance. It shows the cash yield on property investments, with the return rate providing an analysis of the business plan for it with potential distributions over the lifetime of the investment.
This option is often used for investment properties that require long-term borrowing. If debt gets included in the transaction, which is the case for most commercial properties, then the actual cash return differs from the standard ROI. That’s when these calculations make sense since it takes all profits and debt into account.
It only measures the return on the actual cash investment. That’s why it provides a more accurate analysis of the overall performance of the investment.
Example of How to Use the Cash-on-Cash Calculation
Let’s say that the total purchase price for a property is $2 million. The investor pays $200,000 as a down payment, with the rest borrowed from a bank. Insurance premiums, maintenance costs, and closing fees reach $20,000, and this figure is what the investor pays out of pocket.
After one year, the investor has paid $50,000 in loan payments, of which 20% is principal repayment. Now the decision gets made to sell the property for $2.2 million after 12 months.
The investor’s cash-on-cash return for the property equals 51.9% after the deal closes.
It is essential to remember that the cash-on-cash formula is not a promised return. It is a forecast that investors can use to take a look at future cash distributions, making it an estimate of what one can expect to receive over the life of the investment.
This principle applies to other investments that involve cash transactions. As long as you remove the initial payment to acquire items from the figures to focus on what you put into it only, then you’ll have a better idea of what to expect when it is time to implement your exit strategy.