- June 5, 2023
- Posted by: Amit Mundhra CA
- Category: Finance & accounting
Cash on cash return is a financial term that is commonly used in the real estate industry to assess the profitability of an investment property. It provides insight into how much money an investor can expect to earn in relation to the cash invested in the property.
How is cash on cash return calculated?
To calculate the cash on cash return, you start by considering the property’s annual pre-tax cash flow. This is calculated by deducting all the expenses i.e. property taxes, insurance, maintenance costs, management fees etc from the total revenue generated from that property.
Next, you need to calculate the total cash investment made in the property. This comprises of the initial purchase price of the property itself, along with any associated costs like closing costs, legal fees, inspection fees, and renovation expenses. However, it does not include any financing or loan amounts.
Once you have above calculations ready, you can apply below formula to calculate the Cash on Cash returns.
Cash on Cash Return = (Annual Pre-tax Cash Flow / Total Cash Investment) x 100
The result is expressed as a percentage, indicating the annual return on the cash invested in the property.
How useful is this cash on cash return metric?
Cash on cash return is a useful parameter for real estate investors as it allows them to evaluate the profitability of an investment property in a more focused manner. It provides an understanding of the return on the actual cash invested, rather than considering the property’s overall value or taking into account the effects of leverage (borrowed funds). By comparing cash on cash returns across different investment opportunities, investors can assess which properties are likely to yield higher returns and make more informed decisions.
Cash on cash return is just one of many factors that real estate investors consider when evaluating properties. But this single factor gives you the basic idea about the future returns of the property you are buying.