Cash on cash return is an important metric in real estate. It measures the revenue generated by a particular property vs. the amount of capital (cash) that the investor had to spend in order to acquire the property. The high cost of commercial real estate means that almost all purchases require long-term financing. In almost all cases, long-term financing requires a large down payment from the borrower.
The point of the down payment is to make sure the borrower has some “skin in the game” because historically, borrowers who put zero money down have been much more likely to default on loans for the simple fact that they really have nothing to lose.
In response to this, analysts developed the concept of cash on cash returns to assess the viability of a particular real estate investment before making it. It’s a simple question of how much money will this property earn each year in relation to the size of the required down payment.
It’s important to remember that cash on cash returns and return on investment (ROI) are two different things. ROI measures the total amount of net profit realized after a property is sold. However, cash on cash is an annual revenue forecast.
Cash on Cash Returns Formula
You can estimate a property’s cash on cash returns by using the formula below:
Annual Gross Revenue ÷ Total Cash Invested = Cash on Cash Return
So, a property that makes $75,000/year after an investor put down $100,000 to buy it has a cash on cash return of 7.5%
$75,000 Gross Revenue ÷ $100,000 Down Payment = 7.5% Cash on Cash returns
Why Cash on Cash Returns are Important
Long-term, buy-and-hold investors need to know how much money they can expect their chosen property to make in a given year. That’s why using the cash on cash return formula is a good way to analyze whether a particular property is a good investment, or which property is the best choice among multiple options. Properties with a low cash on cash return rate may not be the best choice for investors who are looking for income-producing properties instead of quick flips.
Frequently Asked Questions
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The main difference between IRR and cash on cash return is that cash on cash is the cash flow from one year while IRR considers all cash flows for the entire holding period.
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A 25% cash on cash return is considered good, but it all depends on your risk appetite. A good cash on cash return in real estate investing is any above 0.45%.
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A cash on cash return is important in real estate investing because investors can use it to determine whether or not a property will provide enough profit.
