Investing in real estate can be profitable, but it requires understanding key financial metrics. One important measure is the cash on cash return, which helps investors evaluate the profitability of a property based on their initial investment.
What is Cash on Cash Return?
Cash on cash return is a percentage that indicates how much cash income a property generates relative to the amount of cash invested. It provides a clear picture of the annual return on the actual cash invested in the property.
How to Calculate Cash on Cash Return
The formula for cash on cash return is:
Cash on Cash Return = (Annual Pre-Tax Cash Flow / Total Cash Invested) x 100
To calculate this, determine the property's annual cash flow after expenses and divide it by the total cash invested, including down payment, closing costs, and other initial expenses.
Why It Matters for Investors
Understanding cash on cash return helps investors compare different properties and assess potential profitability. A higher percentage indicates a better return relative to the cash invested, aiding in making informed decisions.
Factors to Consider
- Expenses: Ensure all expenses, including taxes, insurance, and maintenance, are included in calculations.
- Vacancy rates: Account for periods when the property might be unoccupied.
- Financing: Cash on cash return focuses on cash invested, not financed amounts.
- Market conditions: Local market trends can impact rental income and expenses.