How to Calculate Cash on Cash Return for Rental Property

Cash on cash return is a financial metric used by real estate investors to evaluate the performance of a rental property. It measures the annual cash income generated by an investment against the total cash amount initially invested. This calculation provides insight into how efficiently an investor’s cash outlay is producing returns. It specifically focuses on the actual cash flow generated, rather than the property’s overall appreciation or total return on investment.

Key Components for Calculation

Calculating cash on cash return requires two primary financial figures: the Annual Pre-Tax Cash Flow and the Total Cash Invested. Annual Pre-Tax Cash Flow represents the net income a property generates over a year, before accounting for income taxes. This figure includes all income sources minus all operating expenses and debt service. The Total Cash Invested encompasses all out-of-pocket funds an investor contributes to acquire and ready the property for rental. These two components form the numerator and denominator of the cash on cash return formula.

Calculating Annual Pre-Tax Cash Flow

To determine the Annual Pre-Tax Cash Flow, an investor must first identify all income streams and then subtract all property-related expenses, including mortgage payments. Gross rental income is the primary source, which is the total rent collected from tenants over a year. Other potential income sources can include:
Laundry fees
Parking fees
Pet fees
Storage fees
Charges for additional services like cleaning or utilities if paid by the tenant

Once all potential income is identified, various operating expenses must be deducted. These include property taxes, which are assessed by local governments and can fluctuate annually. Insurance premiums for landlord and hazard policies are also common expenses, often included in monthly mortgage payments. Maintenance and repairs, covering routine upkeep like landscaping, pest control, and emergency fixes, are recurring costs.

Property management fees, ranging from 8% to 12% of collected rent, are deducted if a third party manages the property. Utilities paid by the owner, such as water, sewer, and trash, also reduce cash flow. A vacancy allowance, estimated at 5% to 10% of gross rental income, should be factored in to account for periods when the property is unoccupied. Finally, the annual mortgage interest payments, which are tax-deductible for rental properties, are subtracted to arrive at the pre-tax cash flow.

Determining Total Cash Invested

The Total Cash Invested represents the cumulative out-of-pocket funds an investor puts into the property from acquisition through its readiness for rental. A significant portion of this total is the down payment, which is the initial cash contribution towards the property’s purchase price. For conventional loans, down payments can vary, but for investment properties, they are higher than for primary residences.

Closing costs are another substantial component, often ranging from 2% to 5% of the loan amount. These costs encompass various fees paid at the close of the transaction, such as:
Appraisal fees
Inspection fees
Loan origination fees
Title insurance
Recording fees
Attorney fees

While some closing costs, like mortgage interest and real estate taxes, may be immediately deductible, many others are added to the property’s basis and recovered through depreciation over its useful life, generally 27.5 years for residential rental property.

Beyond the initial purchase, any upfront renovation or repair costs incurred to make the property habitable and marketable are included. These could involve significant capital expenditures like roof replacements or HVAC upgrades. Other initial fees, such as business registration, licensing, or tenant screening fees, also contribute to the total cash invested before the property begins generating income.

Applying the Cash on Cash Formula

Once the Annual Pre-Tax Cash Flow and the Total Cash Invested have been accurately determined, the final step involves applying the cash on cash return formula. The formula is expressed as a percentage: (Annual Pre-Tax Cash Flow / Total Cash Invested) x 100.

To perform the calculation, the investor takes the previously calculated Annual Pre-Tax Cash Flow and divides it by the Total Cash Invested. For instance, if a property generates $10,000 in Annual Pre-Tax Cash Flow and the investor initially put down $100,000 in cash, the calculation would be ($10,000 / $100,000) x 100. The result is then expressed as a percentage, which in this example would be 10%.

Understanding Your Calculation

The resulting cash on cash return percentage indicates the annual rate of return on the specific cash equity invested in a rental property. A higher percentage suggests that the investment is generating more cash income relative to the initial cash outlay. Investors use this metric to gauge the efficiency of their invested capital and to compare different investment opportunities.

This metric is particularly useful for evaluating properties that involve debt financing, as it specifically measures the return on the cash an investor has personally contributed. It allows for a quick assessment of a property’s cash flow potential, helping investors determine if a prospective investment aligns with their financial goals. A positive cash on cash return signifies that the property is generating more income than its operating and financing costs, indicating a sound investment.