Cash-on-Cash Return

What Is Cash-on-Cash Return?

Cash-On-Cash Return (COC) is the rate of return ratio that calculates the total cash earned on the total cash invested in a deal.

The cash income earned on cash invested in a property is calculated using a cash-on-cash return. This rate of return is frequently employed in real estate transactions to measure the annual returns an investor makes in relation to the annual mortgages paid.

The annual return the investor received on the property is compared to the amount of the mortgage that was paid in the same year to determine the cash-on-cash return. One of the most significant calculations of real estate ROI is regarded as being quite simple to understand.

COC is a metric typically used to gauge the success of commercial real estate investments, also known as the cash yield on an investment in real estate.

Business owners and investors can analyze the business strategy for a property and the possible cash distributions throughout the course of the investment by looking at the cash-on-cash return rate.

It is also known as the cash flow in a deal or pre-tax property. Cash on cash return is generally a term that is used in the real estate industry. 

When assessing new investment properties or opportunities, you almost always want to conduct an extensive financial analysis. 

There are three important rates of return in real estate investment that you must know how to calculate:

1. One is the return on assets (Cap Rate - Capitalization Rate)
2. One is the return on investment (ROI - Return On Investment)
3. One is the cash rate of return on cash (Cash on Cash Return)

ROI, potential risks and CAPEX, COC, and typically things that can be done to get the utmost value for your investment. 

Although there are terms like cap rate and Internal rate of return (IRR), nine times out of 10, your cash-on-cash return is by far one of the single most important factors you need to consider when purchasing a new deal.

Understanding Cash-on-Cash Return

A profit rate known as cash return determines how much of the total return obtained for cash invested in a transaction was received. 

Utilizing the calculator, the pre-tax cash flow for a specific period is divided by the total cash invested after the procedure to determine the amount of cash needed for real estate, rental properties, or investment. 

Also known as the cash yield, a "free and clear" yield is its unleveraged equivalent to cashback, a leveraged (post-debt) statistic. 

The cash return is usually expressed as a percentage. While this ratio can be applied to various business situations, it is most commonly used in commercial real estate transactions.

Cash on Cash Return = Annual Before Tax Cash Flow / Total Cash Invested

Annual Before Tax Cash Flow = (Gross Scheduled Rent + Other Income) - (Vacancy + Operating Expenses + Annual Mortgage Payments)

Cash-on-Cash Return Example

Let's say you bought a rental property for a nice round sum, say $300,000. You have enough money to pay everything in one lump sum if you rent it out for $3,000 a month but have a maintenance fee of $1,000 a month. 

Your annual pre-tax cash flow is then $24,000: 

($3,000 – $1,000) x 12 months = $24,000. 

Divided by the investment amount ($300,000), the cash return is 

24,000 / 300,000, or 8%.

Consider another scenario where the expected investment is $200,000. However, you sign up for a mortgage with a 20% down payment ($40,000). Quarterly rental income and maintenance costs are the same as in the previous case. 

But you now have to pay $1,000 a month on your mortgage. This means that your pre-tax cash flow is $12,000: 

($3,000 - $1,000 - $1,000) x 12, 

And your rental property has a cash return of:

12,000 / 40,000 or just 30%.

This is a very simple way for a business owner or an investor to understand the cash flow analysis of their investment, aside from the CAP rate, which measures a property's yield in a one-year time frame. 

As more stocks are invested, the calculated skew is lower, assuming revenues and costs remain constant. Of course, borrowing costs affect cash returns. Therefore, this calculation can encourage investors to shop around for better loan rates and terms.

Differences between COC and ROI

Although cash on cash return (COC) and return on investment (ROI) are used interchangeably, they have yet to be considered the same use regarding a course of action and what the term provides in real life. 

Cash flow and/or cash on cash return is a function of your initial investment divided by the total investment price, which gives you the COC percentage return on whether the investment is a deal or not a deal.

ROI, on the other hand, is a function of net income and price, which determines the overall return on investment over the life of the business or property.

How Is Cash-on-Cash Return Calculated?

Reliant Real Estate Management, LLC states that a company or entity purchases a property for $2 million, puts down a $200,000 cash payment, and borrows $1.9M. The company also pays $20,000 cash for miscellaneous costs out of pocket. 

The entity decides that this property can earn him a pretty flip and prices the home to sell for $2.1 million after paying $50,000 in loan payments, including a principal repayment of $5,000.

This means the investor's total cash outflow is $270,000 

[$200,000 + $20,000 + $50000] = $270,000 

And cash inflow is $200,000 

[$2,100,000 - $1,900,000] = $200,000 

The return is 51.85% 

[($205,000 - $135,000) ÷ $135,000] = 51.85%

The formula may be complex for individuals who have never analyzed a deal. Still, this is a simple formula for investors, business owners, and finance-minded people who can project your deal returns.

A practical example of calculating cash on cash return is as follows:

Assume that you are considering purchasing a rental property for $200,000. The property is expected to generate an annual rental income of $20,000 and has annual operating expenses of $10,000, including property taxes, insurance, and maintenance.

To calculate, you would divide the annual pre-tax cash flow

$20,000 - $10,000 = $10,000 

by the upfront cash investment (the $200,000 purchase price). 

This gives you cash on cash return of 

$10,000 / $200,000 = 0.05 = 5%

This means that for every dollar you invest in the property, you can expect to receive a return of 5 cents in the form of cash flow. 

In this case, the cash-on-cash return would be higher if the property was purchased with a mortgage, as the return would be calculated on the cash invested rather than the total purchase price.

Factors that increase or decrease cash-on-cash return

There are always factors that can increase or decrease your investments or, in this case, your cash-on-cash return. As mentioned in this article, what is this super important formula? It is the price point of your investment/deal/property divided by your invested cash.

Your COC will only decrease or increase if your operating expenses change. Some factors that may adjust your returns are as follows:

• Initial Cash Down Payment
• Operating Expenses
• Financing With Leverage
• Value Adding Opportunities
• Favorable Financing Terms & Conditions
• Renovations Or Construction Costs (if you are purchasing a property)
• Rental Income
• Taxes & Their Benefits
• Vacancy & Turnover
• Market Conditions
• Regulatory Changes

These are some highly frequent items that can occur on my deal, and you're right. That's the nature of investing. That is why you must do your due diligence on any investment deal and property you may be getting into.

It may sound simple and cliche, but this is very important. You can run the numbers all day as you should, but if you don't dare to pull the trigger, you will be someone considered to have the unwanted disease of "analysis paralysis." 

Conclusion

From an investment point of view, everyone wants to generate as high a return as possible on the limited capital invested. In addition, many people need to consider the renter's repayment of the landlord's loan principal, which increases the home's equity when calculating the yield.

From the previous formula for calculating the return on investment, it is easy to find that a higher rate of return can be obtained if the investment capital is reduced. 

That's true, but excessive use of financial leverage can lead to negative cash flow, so be sure first to ensure you have a stable source of funds to cover this funding gap.

However, the bank can decide how much the down payment is based on credit or other conditions. Credit is purchasing power in the United States. 

The above analysis shows that the bank interest rate is a major factor in determining Cash-on-Cash Return. Therefore, investing in rental property is a good choice at a time when interest rates are still historically low. 

Should you choose a few apartments, semi-detached, or detached houses to start investing in? This depends on the investor's credit and cash amount. In the long run, real estate appreciation far exceeds inflation.

Researched & Authored by Yihan Du | LinkedIn

Reviewed & Edited by Ankit Sinha | LinkedIn

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