How to Figure Cash on Cash Return for Real Estate

Cash on Cash Return is a financial metric used by real estate investors to evaluate the annual income generated by a property in relation to the actual cash invested. It provides a straightforward percentage that indicates the profitability of an investment based purely on the cash outlay. It is a valuable tool for assessing the performance of income-generating properties, particularly those purchased with financing.

Key Elements for Calculation

Calculating Cash on Cash Return requires two primary components: the annual pre-tax cash flow and the total cash invested. Understanding what constitutes these figures is fundamental before proceeding with the calculation. Each element comprises several specific financial inputs that directly affect the final percentage.

Annual Pre-Tax Cash Flow

Annual pre-tax cash flow represents the income a property generates after accounting for its operating expenses, but before considering any debt service or income taxes. To determine this, an investor first tallies all rental income received from the property over a 12-month period. From this gross income, all operating expenses incurred during the same period are subtracted. These expenses typically include property taxes, which can vary significantly by location but are a consistent annual cost, and property insurance premiums, which protect against unforeseen events.

Other common operating expenses include maintenance and repair costs, which can average around 1% of the property’s value annually for routine upkeep. Property management fees, often ranging from 8% to 12% of the gross monthly rent, are also deducted if a manager is employed. Additionally, any utilities paid by the owner, such as water or sewer services, and contributions to a reserve fund for future capital expenditures like roof replacement or HVAC repairs, are factored into the total expenses.

Total Cash Invested

The second essential component is the total cash invested, which encompasses all out-of-pocket funds an investor commits to acquiring and preparing the property for cash flow. This includes the initial down payment made on the property, which can typically range from 20% to 25% of the purchase price for investment properties. Closing costs are also a significant part of the cash invested, often amounting to 2% to 5% of the loan amount or purchase price, covering items like loan origination fees, title insurance, and legal fees.

Furthermore, any initial renovation or repair costs required to make the property habitable or rentable are added to the total cash invested. This could involve expenses for painting, flooring, appliance upgrades, or more extensive structural repairs. Other miscellaneous initial expenses, such as appraisal fees or inspection costs, also contribute to the overall cash outlay. Summing these figures provides a comprehensive total of the investor’s direct cash contribution to the investment.

Performing the Calculation

Once the annual pre-tax cash flow and total cash invested are accurately determined, calculating the Cash on Cash Return becomes a straightforward application of a specific formula. The formula is expressed as: (Annual Pre-Tax Cash Flow / Total Cash Invested) x 100. This calculation converts the ratio of cash flow to cash invested into a percentage, making it easily interpretable.

To illustrate, consider a hypothetical scenario where an investor purchases a rental property. Suppose the annual pre-tax cash flow for this property is determined to be $10,000.

Next, consider the total cash invested for this same property. This includes the down payment, for example, $50,000, along with closing costs of $5,000 and initial renovation expenses of $15,000. Summing these amounts yields a total cash invested of $70,000.

With both figures established, the calculation proceeds by dividing the annual pre-tax cash flow by the total cash invested. In this example, $10,000 is divided by $70,000, resulting in approximately 0.1428. To express this as a percentage, the result is multiplied by 100. Therefore, 0.1428 multiplied by 100 equals 14.28%.

This 14.28% represents the Cash on Cash Return for this particular investment. The calculation provides a clear percentage return on the actual cash an investor has put into a property. It directly reflects how efficiently the invested cash is generating income, offering a concise measure of the property’s cash-generating performance relative to the capital deployed.

Understanding the Result

For instance, a Cash on Cash Return of 10% means that for every dollar of cash invested, the property generates ten cents in pre-tax cash flow each year.

Investors often use this metric to compare the profitability of different real estate investment opportunities, especially when those opportunities involve varying levels of financing. A higher Cash on Cash Return percentage generally indicates a more efficient use of the investor’s capital, suggesting a stronger cash flow relative to the money put down. This can be particularly appealing for investors prioritizing immediate cash flow from their properties.

While there is no universally “good” Cash on Cash Return percentage, many real estate investors look for returns in the range of 8% to 12% or higher. The desired percentage can depend on various factors, including the investor’s financial goals, the property’s location, and the perceived risk of the investment. It serves as a valuable benchmark for assessing the cash-generating performance of an investment over a single year.

The utility of Cash on Cash Return lies in its focus on the actual cash invested, making it particularly relevant for leveraged real estate deals. Since it considers only the cash an investor has put into the property, rather than the total property value, it offers a distinct perspective on the return on equity. This metric helps investors understand the direct impact of their cash investment on the property’s annual cash generation.