Cash Flows From Investing Do Not Include Cash Flows From Cash On Cash Return, The Formula And Calculation

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Cash On Cash Return, The Formula And Calculation

Cash on Cash (CoC) provides real estate investors with an easy way to compare the profitability of similar income producing properties or to quickly appreciate it with another investment opportunity.

CoC, however, is not a particularly powerful tool for measuring rental property profitability and currently receives less attention in real estate investment analysis than it did a few years ago.

One drawback lies in the fact that cash back does not take into account the time value of money. The cash refund must be limited to a simple measurement of the cash flow of the residential property in the first year, not future year cash flows.

Regardless, cash on cash is not without validity and still offers seasoned investors and real estate novices the advantage that has always attributed to its popularity.

The CoC return measures the ratio between the projected cash flow in the first year and the amount of the real estate investor’s initial cash investment to purchase the rental property. Therefore, CoC is always expressed as a percentage.

“First year cash flow” (or annual cash flow) is the amount of cash a property is expected to generate during its first year of operation. “Initial investment” (money invested; sometimes called acquisition cost) is the total amount of money invested including down payment, credit scores, escrow and title fees, appraisal and inspection costs.

Okay, let’s start with an example and then do a calculation.

Let’s say you’re interested in buying a property with six units that each pay $1,000 a month in rent. You estimate that operating expenses for the first year will be $28,800. You are planning a new mortgage with a down payment of $126,000, a credit score of $2,940, and a monthly payment of $1,956. You estimate that your closing costs (escrow, title, inspections and appraisal fees) will be $2,100.

Formula: annual cash flow / cash investment = cash on cash return

In this case, you would need to do five calculations (to determine the annual cash flow and cash investment) before you can calculate the cash on hand.

  1. Annual rental income: (6 units x $1,000) x 12 = $72,000

  2. Net Operating Income (NOI; income less expenses): $72,000 – $28,800 = $43,200

  3. Annual debt service (mortgage payment): $1,956 x 12 = $23,472

  4. Annual cash flow (net operating income less payments): $43,200 – $23,472 = $19,728

  5. Cash investment (down payment + points + closing costs): $126,000 + 2,940 + 2,100 = $131,040

Calculation: (annual cash flow / cash investment = cash on cash return) $19,728 / $131,040 = 15.06%

Now that you know that this specific investment opportunity is yielding a 15.06% CoC return, you can compare it to similar properties or alternative investments such as the T-Bill rate and decide whether or not you want to proceed with the purchase.

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