Cash on cash (CoC) provides an easy way for real estate investors to quickly compare the performance of similar income generating properties or compare it to another investment opportunity.
CoC, however, is not a particularly powerful tool for measuring rental income property profitability and currently receives less attention in real estate investment analysis than it did a few years ago.
One deficiency lies in the fact that cash for cash does not take into account the time value of money. The cash-on-cash return should be limited to simply measuring the first-year cash flow of a residential income property and not the future-year cash flows.
However, cash on cash is not without validity and still offers experienced and beginning real estate investors a benefit that has always been attributed to its popularity.
The CoC return measures the relationship between the anticipated first-year cash flow and the amount of initial cash investment made by the real estate investor to purchase the rental property. Therefore, CoC is always expressed as a percentage.
“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. “Upfront investment” (cash invested; sometimes called acquisition cost) is the total amount of cash invested, including down payment, loan points, escrow and title fees, appraisal, and inspection costs.
Ok, let’s start with an example and then do the math.
Suppose you are interested in buying a property with six units, each paying $1,000 per month in rent. You estimate that the operating expenses for the first year will be $28,800. You are planning a new mortgage with a down payment of $126,000, loan points of $2,940, and a monthly payment of $1,956. You estimate your closing costs (escrow, title, inspections, and appraisal fees) to be $2,100.
Formula: Annual Cash Flow / Cash Investment = Cash over Cash Yield
In this case, you will need to perform five calculations (to determine Annual Cash Flow and Cash Investment) before you can calculate Cash on Cash.
-
Annual rental income: (6 units x $1,000) x 12 = $72,000
-
Net Operating Income (NOI; income minus expenses): $72,000 – 28,800 = $43,200
-
Annual Debt Service (mortgage payment): $1,956 x 12 = $23,472
-
Annual CashFlow (net operating income minus pay): $43,200 – 23,472 = $19,728
-
Cash investment (down payment + points + closing costs): $126,000 + 2,940 + 2,100 = $131,040
Calculation: (Annual Cash Flow / Cash Investment = Cash on Cash Return) $19,728 / $131,040 = 15.06%
Now that you know that this specific investment opportunity generates a CoC return of 15.06%, you can compare it to similar properties or alternative investments, such as a T-Bill rate, and decide whether or not to proceed with the purchase.