Cash-on-cash return is a significant metric in real estate that helps you calculate the performance of an asset. It is a return rate of cash income invested in real estate transactions. Typically, investors calculate this return by dividing their cash flow (net operating profits) (before tax) by their initial investment amount.
Cash on cash return = yearly cash flow/total cash investment
Cash Flow = revenue - operating expenses - reserves - debt service.
As detailed above, net operating amount refers to your annual rental income (subtracting operating expenses). Commercial investors calculate the cash flow annually before the tax figure on the real estate investment proforma. The equity investment is the total purchase cost less loan proceeds.
Ideal Cash-On Cash Percentage
There are various opinions when it comes to determining an ideal cash-on-cash percentage. For some investors, COC above 8% is ideal while for others this rate ranges between 8% and 12 %. There are many investors who do not even consider cash on cash return that is below 20 %. That is to say, COC greatly varies from one investor to another, property to property, and location to location.
Cash on Cash Return Example
Now let us understand COC formula with the help of a simple example that illustrates the process of cash-on- cash return.
Suppose you have to evaluate a commercial property with an estimated one-year cash flow (before $60,000 taxes). The negotiated property cost is $1,200,000. Also assume that you have secured a loan for $900,000 with 75 percent loan to value ratio.
Now let us calculate what will be your annual cash -on-cash return by inserting the values.
$60, 000/$300,000 = 0.20 equals to 20%
It is a simple investment measure of your one-year cash -on-cash returns, which is equal to 20 percent.