How to Calculate Cash-on-Cash Return: The Method and Formula
The cash-on-cash (CoC) return provides a quick and easy way for real estate investors to compare the profitability of similar real estate investment properties, or to gauge it against another (non-real estate) investment opportunity.
Okay, but with that said, it should be noted that cash-on-cash is not a particularly powerful tool for measuring the profitability of rental income property, and currently gets less attention in real estate investment analysis than it used to receive some years ago.
One shortcoming lies in the fact that cash on cash return does not take into account time value of money (i.e., the idea that a dollar today is worth more than a dollar in the future). Cash-on-cash return must be restricted to simply measuring a residential income property's first year cash flow, and not any of its future year's cash flows.
Nonetheless, cash-on-cash still offers seasoned and beginning real estate investors a valid benefit. So let's dig in.
Practically speaking, the cash-on-cash return measures the ratio between a rental property's anticipated cash flow during the first year to the amount of initial cash investment made by the real estate investor to purchase the rental property. Hence, cash-on-cash is always expressed as a percentage.
Since the property's "first year cash flow" and "initial investment" are both paramount to the CoC calculation, it seemed needful to explain each.
- The "first-year cash flow" (or annual cash flow) is the amount of money the property is expected to generate during the first year of operation.
- The "initial investment" (sometimes called total investment) is the total amount of cash invested including down payment, loan points, and cost of acquisition (escrow and title fees, appraisal, and inspection costs).
The formula is:
Annual Cash Flow / Total Investment = Cash-on-Cash Return
To show you how to make the calculation let's consider an example.
Suppose you are interested in purchasing an apartment building with the following assumptions and want to determine what your cash-on-cash rate of return would be from the investment.
- 6 units total
- Acquisition costs: $5,000
- Rent: $1,000 each monthly
- Vacancy allowance: 5%
- Other income: $720 annually
- Operating expenses: $27,781 annually
- Replacement reserves: $1,800 annually
- Mortgage: $350,000,
- Loan points: $3,500,
- Annual payment: $25,181
Okay, now let's use that data to determine the "annual cash flow" and "total Investment" required to compute for the cash-on-cash rate of return.
Annual Cash Flow
- Gross Scheduled Income ((6 units x $1,000) x 12): = $72,000
- Gross Operating Income (GSI - vacancy + other income): $72,000 - 3,600 + 720 = $69,120
- Net Operating Income (GOI - operating expenses): $69,120 - 27,781 = $41,331
- Annual Cash Flow = (net operating income - replacement reserve - debt service)
- Result: $41,331 - 1,800 - 25,181 = $14,350
- Total Investment = (down payment + acquisition costs + loan points)
- Result: $150,000 + 5,000 + 3,500 = $158,500
Annual Cash Flow / Total Investment = Cash on Cash Return
$14,350 / $158,500 = 9.05%
Now that you know this specific real estate investment yields a 9.05% cash-on-cash return, you can compare it to other similar investment real estate, or alternative investments such as a T-Bill rate, and decide whether or not to proceed with a purchase.