With this real estate investing article, we want to discuss cash-on-cash return by exploring its meaning, benefits and shortcomings, popularity amongst real estate investors, and then the cash-on-cash formula alongside several examples.
So let’s get started.
The cash-on-cash return (or equity dividend rate) procedures the ratio between a property’s anticipated first year’s cash flow before tax (CFBT) to the amount of preliminary cash investment made by the real estate buyer to purchase the rental property.
Here’s the idea: cash on cash could be the percentage of cash flow to cash investment.
The popularity and use of cash-on-cash in real estate investing is because it provides traders with an easy way to compare the profitability of several investment opportunities quickly. For example , an investor can compare the first-year yield of a real estate investment based on its cash-on-cash (or CoC) to the yield offered by the bank on a CD. In this case, for example, the investor might decide to invest his cash into an apartment complex that returns a CoC associated with 7. 6% rather than into a CD paying 3%, and vice versa.
Generally speaking, though, cash-on-cash return is not considered a particularly powerful tool to get measuring an income property’s profitability because it doesn’t consider the time value of money. In other words, because it doesn’t compound or discount money over time, CoC is fixed to measuring an investment property’s cash flow in the first year of ownership only.
Nonetheless, the cash-on-cash return is not without validity. It will certainly provide real estate investors a quick way to compare investment opportunities and comparable income-producing properties.
How to Calculate
Cash on Cash Return = Yearly Cash Flow / Cash Investment
What it takes
Before we consider an example, let’s be sure we understand the components of the particular formula. This will be crucial for you to compute cash-on-cash correctly in your own rental home analysis.
1) Annual Cash Flow – This is the cash flow before tax (CFBT) in opposition to the cash flow after taxes (CFAT). In other words, it’s the cash flow for the first-year without an adjustment for Federal government income tax. CFBT is calculated by computing annual rental income less annual operating expense less yearly debt service or loan transaction.
2) Cash Investment – This is the total amount of initial cash required to purchase the property and includes the down payment, loan points, escrow plus title fees, appraisal, and examination costs.
Okay, let’s figure out a cash-on-cash return.
You’re analyzing the profitability of a six-unit apartment building according to the following scenario. Each one of the six units collects $1, 500 per month. You estimate the first year’s operating expenses will be $28, 800. Your mortgage requires $126, 500 down, loan points of $2, 940, and a monthly loan transaction of $1, 956. You estimation your closing costs, i. electronic., escrow, title, inspections, and appraisal fees, at $2, 100.
Very first, compute the annual cash flow:
Gross Scheduled Income $72, 000 ((6 units x $1, 000) by 12)) less Operating Expenses associated with $28, 800 equals $43, 200 (Net Operating Income) less Mortgage Payment $23, 472 ($1, 956 x 12) = $19, 728 Cash Flow
Next, compute your cash investment:
Down Payment of $126, 000 in addition Loan Points of $2, 940 plus Closing Costs of $2, 100 = $131, 040 Money Investment
Finally, compute CoC:
Cash on Cash Return = Yearly Cash Flow / Cash Investment, or even, $19, 728 / $131, 040 = 15. 06%
Okay, right now let’s apply it.
You’re trying to decide where to invest $126, 000 money. You can invest it in a 3% T-Bill at your local bank or, as you just discovered, you can purchase the six-unit rental income property and get a cash-on-cash return of 15. 06%.
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What do you do next? You might want to perform a full-blown real estate analysis on the home and look at some other key results and measures. Though on the surface, the investment real estate appears to be the most advisable real estate investing choice, you can’t make a decision with out more information and a more complete real-estate analysis.
But here’s the stipulation. Be sure to use credible property information for your analysis; confirm that everything the seller or agent gives to you is usually complete and accurate; compute all of numbers and property data concisely and carefully.