Those who invest in rental property can calculate their returns using CoC or Cash-on-Cash Return. This is currently the most popular among the metrics used by real estate investors for investment properties. This article will discuss how to calculate cash-on-cash return.

Real estate investors use many metrics to measure the performance of various income-generating properties and use them to decide whether to buy or not to buy a property. A few of the most used metrics are gross operating income (GOI), gross rent multiplier (GRM), debt coverage ratio (DCR), loan-to-value ratio (LTV), net operating income (NOI), internal rate of return (IRR) and capitalization rate (cap rate).

What is Cash On Cash Return (CoC)?

Cash on cash return, sometimes referred to as the cash yield, is a metric used to measure the return on investment for a real estate property that helps investors evaluate the potential return on their investment. It measures the annual pre-tax cash flow generated by a property relative to the initial amount of cash invested.

In other words, it calculates the return on the actual cash invested in a property, providing a clear picture of the investment’s performance. This metric is particularly useful for real estate investors as it focuses on the cash yield of the investment, allowing them to assess how well their money is working for them.

As an investor, if you understand cash on cash return, you can make more informed decisions about which properties to invest in and how to manage their portfolios effectively.

How to Calculate Cash-on-Cash Return?

Now, let’s look at how you can calculate cash on cash return using the cash return formula and look at some examples.

Cash Return Formula

The calculation of cash on cash return is easy. CoC is equivalent to the annual cash flow over total cash invested. The formula is:

Cash-on-Cash Return (%) = Annual Pre-Tax Cash Flow ÷ Invested Equity

Where:

• Annual Pre-Tax Cash Flow is the net operating income (NOI) minus debt service payments.
• Total Amount of Cash Invested, or equity invested, is the initial amount of cash invested in the investment property (real estate).

The calculation will vary depending on whether you, as an investor, acquire it through a loan or acquire it and pay in cash.

Example #1 to Calculate CoC

To cite a clear example of rental property purchased in cash:

The investor buys a rental real estate property of $800,000 in cash, and he/she receives a monthly rental of $3000 and expenses of $1,000.

So, the calculation would be total income in a month of $3,000 less $1,000 expenses equals $2,000.

Hence, to calculate the annual income, it would be 12 months multiplied by $2000, which results in $24,000. This $24,000 represents the annual cash flow generated by the property.

The CoC would be $24,000 divided by $800,000 and multiplied by 100 to get it in percent = 3%

A 3% cash-on-cash return means that for every dollar the investor puts into the real estate property, they are getting back 3 cents each year in pre-tax cash flow.

Essentially, it’s a way to measure how effectively the investor’s money is generating income from the property.

Example #2 to Calculate CoC

Let’s look at another example.

For example, if a property generates $50,000 in annual pre-tax cash flow and the investor has $200,000 in invested equity, the cash on cash return would be:

Cash on Cash Return (%) = $50,000 ÷ $200,000 = 25%

In this example, the total amount of equity invested is less than in the previous example. At the same time, the income generated is also higher, so 25% of CoC means that for every dollar you invest in this real estate, you will generate 25 cents each year.

This calculation will help you as an investor to understand the cash return you can expect from your investment property. In such a way, it is easier to compare different investment opportunities and choose the most profitable ones for you.

Key Components of Cash On Cash Return

When you calculate the cash on cash return, you need to take into account several key components:

Net Operating Income (NOI)

The first one is Net Operating Income, which is the annual income from the property minus the operating expenses. NOI is the measure of the property’s profitability before the financing costs.

Debt Service Payments

The second one is debt service payments, which include mortgage payments, interest, and principal repayment. These payments are subtracted from the net operating income to get the annual pre-tax cash flow.

Annual Pre-Tax Cash Flow

The annual pre-tax cash flow is the net operating income, which is the rental income minus the debt service payments and operating expenses. This is the amount of cash flow that the property generates before taxes.

The annual cash flow is the key component to calculate the cash on cash return.

Equity Invested

The last one is equity invested, which is the amount of cash that you put into the property at the beginning, including the down payment and other upfront costs.

Now that you know the key components, you can easily calculate your cash-on-cash return and make the right investment decisions.

Limitations of the Cash On Cash Return Metric

While cash on cash return is useful, it has its limitations. For example:

• It doesn’t account for changes in income and expenses over time. So, if your rental income increases or you have an unexpected expense, the actual cash return will be different.
• It doesn’t consider long-term appreciation. Cash on cash return only looks at the cash flow of the property, not the increase in value over time.
• Also, it doesn’t account for the time value of money. The metric treats all cash flows as equal, regardless of when they happen, which can be misleading for long-term investments.
• It’s sensitive to financing costs and debt. High financing costs or high debt can reduce the cash-on-cash return even if the property is profitable.

Despite that, cash-on-cash return is still a useful tool for real estate investors to use. By knowing its limitations, you can use it properly.

What To Include In Cash Yield Calculation?

The operating expenses landlords will put on the cash-on-cash return calculation are generally the expenses landlords spend on the day-to-day operations of their rental properties.

These costs include:

• Advertising and marketing: to cite examples under this criterion, rental property is still not occupied, or the space will be vacant in the next few months, or the landlord is looking for partners or selling the property
• Property insurance: this must be updated yearly
• Property taxes: taxes are shouldered by the land owners and not the tenants
• Trash collection: although not as expensive, any cost must be included
• Utilities: utilities include water, electricity, and the like
• Property management: this includes the salary of the managers and employees, if any, and their day-to-day expenses as they perform their jobs
• Pest control: This is also important as getting this service can help you keep a pest-free environment

It is important that all expenses listed are part of the operating expenses to ensure accurate results. For example, if you use printer ink, you can only list expenses under this criterion if the printing is used for marketing purposes, such as printing flyers and posters.

To name few of the expenses that must not be included under expenses are:

• Personal labor of landlord/s
• Fines and penalties for law violations or anything else of the like
• Lobbying expenses
• Political contributions
• Charitable donations
• Illegal bribes or kickbacks

Common Mistakes to Avoid When Calculating Cash-On-Cash Return

Now let’s look at some mistakes you must avoid:

1. Not Calculating Annual Cash Flow Correctly

One of the biggest mistakes to watch out for when calculating cash-on-cash returns is not calculating annual cash flow correctly.

So make sure you account for all cash in and out of your investment property. Accurate calculation of these is key for real estate investors to calculate cash yield and actual cash return.

Make sure all the info you put into cash-on-cash returns is correct, or you won’t find what you’re looking for.

2. Ignoring Some Cash Inflows and Outflows

Another mistake is ignoring some cash inflows and outflows of the property. For example, not including mortgage payments or subtracting operating expenses from the net cash flow can give you an incorrect cash-on-cash return calculation.

Make sure the cash flow reflects all aspects of income and expenses to determine the true cash return on their investment property.

3. Not Accounting for Different Assumptions for Different Properties

And comparing cash on cash return across different properties without accounting for the underlying assumptions.

Each property may have different financing options, market conditions, and expenses that can impact cash yield and equity invested.

Let’s say two investment properties in different real estate markets. Property A is in a hot urban area with high market value and demand; Property B is in a rural area with stagnant growth, low rental demand, and, therefore, lower market value.

For Property A, the investor is getting increasing income from rent due to the favorable market conditions, so the annual cash flow is higher. Even though the initial cash invested is higher because of the competitive market, the cash-on-cash return is still attractive because of the high income and potential appreciation.

Property B has lower income and less demand, so cash flow is lower. Even though initial cash invested is lower, cash-on-cash return can be less attractive because of limited income and slow growth.

This example shows you that you must consider market conditions when comparing cash-on-cash returns across different properties.

So be careful and account for these when you calculate cash-on-cash return.

Cash on Cash Return vs. Other Return Metrics

You see, cash-on-cash return is different from other return metrics like return on investment (ROI) and internal rate of return (IRR).

Return on Investment (ROI)

ROI is a return metric that considers the return on the whole investment property, including debt and financing costs. In contrast, cash-on-cash return looks at the return on the actual cash invested, which is pre-tax cash flow.

Internal Rate of Return

Whereas IRR is an annualized rate of return that takes into account the time value of money, it looks at the investment over time, including net cash flow and future sales.