Cash-on-Cash Return: Key Metric for Real Estate Investors

Cash on cash return is a financial metric used by real estate investors to evaluate the profitability of a real estate investment. It takes into account the annual pre-tax cash flow of the investment relative to the amount of cash invested. The Indian real estate sector is experiencing a boom, with land, flats, and buildings being sold without any hassle and buyers lined up to invest a hefty amount in buying real estate. If you look at real estate prices, a home that was worth lakhs only a few years ago is now being sold in crores, and numerous buyers are interested in buying the property. However, when it comes to buying real estate, some individuals solely buy real estate for investment purposes. The aim is to buy the property and sell it when the price is high to make good profits. However, as with all investments, it is important to evaluate the profitability of a real estate investment.

This is where cash on cash return comes in. This blog will help you understand the cash on cash return meaning and how you can use the calculations to evaluate the returns you make from your real estate investments. 

Cash on cash return meaning refers to a financial metric that measures the total returns generated by an individual from a real estate investment. This means that COCR measures the income earned by an owner of a real estate property based on the initial investment made to acquire the property. Cash on cash return helps investors looking to invest in real estate to determine their approximate returns for a real estate investment or actual returns after owning the property for a certain period.

Cash-on-cash return measures the returns made on a real estate investment as a ratio of the total amount of income generated by renting out the property and the amount initially invested to buy the property.

Also Read: What Is a Good Return on Investments

• Cash on cash return evaluates the return earned by the owner of a real estate property when compared to the initial invested amount.
• The formula for cash on cash return is Annual pre-tax cash flow / Total cash invested.
• Cash on cash return helps investors compare two or more real estate investments based on the returns they can generate.
• Ideal cash on cash return percentage ranges from 8%-12%. 

Some people purchase real estate as their primary residence without any intention of generating income from the investment. Since there is no return potential for such a situation, there is no return calculator. However, some people buy real estate as an investment to be rented out to others for regular income. Since the main motive is to maximise returns, the calculations on the returns are done through cash-on-cash returns.

Cash on cash return measures the total returns earned by a real estate owner by taking in the total income earned through rent and the initial investment amount. It takes into account the equity dividend rate to determine the pre-tax cash flow relative to the amount of money initially invested. Most investors use cash on cash return to analyse the return potential when long-term debt is included. As most investors buy real estate after availing of a long-term loan, the actual returns change when compared to the standard returns. Cash on cash return requires deep analysis of various real estate factors, such as the location, area prospects, commercial demand, etc. For example, if you have a property and have earned rental income, you can use cash on cash return to know how much return you have earned from the property compared to the initial investment amount.

Also Read: How to Calculate Mutual Fund Return

Here is the formula for cash on cash return:

Cash on cash return = Annual pre-tax cash flow / Total cash invested

Here,

• Annual pre-tax cash flow is the income generated by the investment (such as rental income) minus operating expenses and debt service (mortgage payments) before taxes.
• The total cash invested is the initial down payment, closing costs, and any other cash paid to buy the property.

First, you must determine the total cash invested in buying the property. This includes a down payment, closing costs, and any other cash paid at the time of purchase. Secondly, determine the pre-tax cash flow, which includes subtracting rental income from operating expenses and the amount of debt payments.

Once you have determined both numbers, put them in the cash on cash return formula, which is:

Cash on cash return = Annual pre-tax cash flow / Total cash invested

You can multiply it by 100 to get a cash on cash return percentage.

Conisder a situtation where you’ve invested in a residential property.  The total cash invested includes a down payment of Rs. 8,00,000 and closing costs of Rs. 1,00,000, making your total cash invested Rs. 9,00,000.

You earn an annual rental income of Rs. 4,00,000 from this property. After deducting operating expenses totaling Rs. 80,000 and annual mortgage payments of Rs. 1,60,000, your annual pre-tax cash flow comes to:

Rs. 4,00,000−Rs. 80,000−Rs. 1,60,000=Rs. 2,60,000

To find the cash on cash return, use the formula:

Annual pre-tax cash flow / Total cash invested

Cash on cash return percentage = Rs. 2,60,000 / Rs. 9,00,000 x 100

Cash on cash return percentage = 28.89%

Hence, in this scenario, your cash on cash return percentage is 28.89%. This means that the property has given you 28.89% returns on your initial invested amount of Rs. 9,00,000.

Also Read: What is the expected return

Here are the advantages of cash on cash return:

• Easy to calculate: The cash-on-cash return is easy and straightforward to calculate. All you have to do is find out the annual pre-tax cash flow and the total cash invested, and you can find the results through a simple formula.
• Investment comparison: Cash on cash return helps investors compare numerous real estate investments based on their return potential. As buying real estate requires a high investment, investors can choose to invest in the one with the highest return potential.
• Performance focus: One of the best advantages of cash on cash return is that it focuses more on performance of the real estate investment. It provides insight into how efficiently a property is generating cash flow relative to the amount invested.

Also Read: What are risk and return

Here are the disadvantages of cash on cash return:

• Ignores property appreciation: Cash on cash return solely focuses on the cash flow generated from the property, not accounting for any increase in the property’s market value over time. This means the appreciation that can increase the property's overall returns is ignored.
• Excludes principal repayment: The cash-on-cash return calculation considers only the annual cash flow relative to the cash invested without factoring in mortgage principal repayments. Although it includes interest payments, it excludes principal repayment even when, with each payment, the loan value reduces and property equity increases.
• No tax impact consideration: One of the most significant disadvantages of cash on cash return is its failure to consider the tax impact owing to deductions, depreciation, or tax liabilities. This leads to the exclusion of tax benefits that can reduce taxable income and increase the overall returns.

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Cash on cash return measures an investment's annual pre-tax cash flow relative to the total cash invested. This calculation provides results related to the immediate returns provided by a real estate investment and highlights how much returns you have earned on the amount you initially invested.

On the other hand, return on investment (ROI) measures the total return relative to the total investment cost, including both capital gains and expenses. ROI considers all sources of profit and costs related to real estate investment, such as capital appreciation, and often considers tax implications that may increase or reduce investor gains.

Also Read: What are medium duration mutual funds

Cash on cash return in percentage form allows you to determine the percentage return you can or are getting from a real estate investment based on the initial invested amount. Experts believe that a cash on cash return percentage between 8%-12% is ideal for a real estate investment to be worth investing. However, there are some investors who believe that it should be higher and between 15%-20%. In the end, an ideal cash on cash return percentage will come down to your investment goals, risk tolerance, and the amount you can invest to buy a real estate property.

Real estate investments have become one of the most basic additions to a financial plan for investors who want steady rental income. However, as there are numerous investment opportunities in the real estate sector, it becomes important that you compare them based on their return potential to choose the one with the highest return potential. Furthermore, it is also crucial that you understand how much returns your real estate investments are giving you to adjust your investments and ensure you do not incur losses. Cash on cash return is an ideal financial metric that can help you analyse the returns relative to the initial investment amount. Now that you know what is cash on cash return, you can make better real estate investment decisions.

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