This series of articles aims to explain the different aspects of investment analysis in real estate investing, which include investment property analysis, comparative market analysis, and the property valuation methods, while also explaining the different aspects of each and the tools used to conduct investment analysis with ease and at high efficiency.
Cash on Cash Return in Real Estate Investing
In the previous articles, we have discussed the general aspects related to investment analysis and went on to write more comprehensive and in-depth articles about the different aspects of investment analysis, such as the market analysis and the investment property analysis which deals with the individual property and the aspects related to it.
While investment property analysis deals with the general characteristics of a property, such as its location, type, and size, as well as the more specific aspects related to the property’s returns and profitability, we highly emphasized the importance of conducting property valuation during investment property analysis, and we went into more details on the different methods used in a property valuation process in order to determine the property’s value based on its price, type, size, and estimated return on investment.
One of the major metrics used in property valuation and in investment analysis, in general, is the cash on cash return value of an investment property.
The purpose of this article is to focus on this specific metric and its use in real estate investment analysis, and how to conduct investment property analysis and property valuation based on cash on cash return to help you find investment properties that will generate the returns that you are hoping for on your investment.
This article will answer the following questions:
- What Is Cash on Cash Return?
- How Is Cash on Cash Return Calculated?
- What Is an Investment Property Calculator?
- What Is Good Cash on Cash Return for an Investment Property?
What Is Cash on Cash Return?
The cash on cash return is one of the main metrics used in the property valuation stage of investment analysis.
When doing property valuation, the value of the cash on cash return indicates the rate of return on an investment property based on the amount of cash that was invested in it, not taking into account the amount of borrowed money through a mortgage or a loan.
The cash on cash return, in this sense, similar to the cap rate, is a type of a return on investment metric that is used in a specific real estate investing situation, especially when doing investment analysis for a rental property.
In short, the cash on cash return, also called the equity dividend rate, is a metric used in real estate investing to determine the amount of profit that you will make, or the rate of return, on an investment property based on the amount of actual cash invested in it.
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How Is Cash on Cash Return Calculated?
The formula for calculating the cash on cash return on an investment property is quite simple:
Cash on Cash Return = NOI (Net Operating Income)/Total Cash Invested
To break it down further, let’s take a look at what the NOI and what the total cash invested mean.
The NOI of an investment property is simply the annual net return on the investment property after discounting all of the operating costs.
The property’s current market value, on the other hand, is just as the name implies; it is the price of the property at the current point in time.
Now, let’s get to the math of this.
In order to calculate the NOI, you first need to calculate the annual gross income of your investment property.
Calculating the annual gross income is a crucial step in any investment analysis. It simply means the sum of the gross income that you make on an investment property over the span of 1 year.
So, let’s suppose that your investment property is a rental property that you’re renting out to tenants for $1,200 per month. The annual gross income for this rental property would be $14,400 ($1,200 x 12).
The net operating income of an investment property is the annual gross income minus all the expenses related to running the property.
So, if the annual gross income of the investment property is $14,400, and its total annual expenses amounts to $7,000, then your net operating income would be $7,400.
Now that you have the value of the NOI, it’s time to identify the total cash invested value for the property valuation.
The total cash invested in this case is simply the amount of actual money that the real estate investor had to pay or put down towards the purchase of the investment property.
This, however, is not exclusive for the amount of money that you’ve paid only for the actual purchase of the property, but also includes the closing costs and rehab costs, as well as loan fees (not loan payments or loan interest).
So, in order to calculate the total cash invested in the property, a real estate investor would first have to determine these values.
The closing costs are the fees that you have to pay to the real estate agent (if you’ve hired one) to help you close the deal, as well as the fees of any other services that you’ve hired, such as a property appraisal or a credit score report.
The rehab costs of an investment property might not apply to all investment properties. But if the property was in need for any level of renovation or rehab, no matter how big or how small, these expenses have to be included in the total cash invested in the purchase of the property.
Finally, the loan fees do not represent the loan payments or the interest rate for the loan or the mortgage, but rather express the amount of money that you’ve paid to acquire the loan from the bank or the lender, such as applications and other similar expenses.
Now that we have broken down the different parts of the equation, let’s see how these values come together in the calculation of the cash on cash return in a simple example:
Let’s suppose that you want to purchase an investment property that has a market price of $400,000. You intend to finance your purchase through an 80% mortgage, meaning that you will be paying 20%, or $80,000, as a down payment from your own cash.
Additionally, the acquisition of a loan and the closing costs, as well as the rehab costs have all amounted to $20,000.
If you add these values together, you end up with $100,000 as the actual total cash invested in the property.
Now, based on our previous example, we know that the NOI for this property is $7,400, so let’s put all the numbers together:
Cash on Cash Return = NOI/Total Cash Invested
Cash on Cash Return = (Annual Gross Income – Expenses)/Total Cash Invested
Cash on Cash Return = ($14,400 – $7,000)/$100,000
Cash on Cash Return = $7,400/$100,000
Cash on Cash Return = 0.074
Since the cash on cash return value is typically expressed as a percentage, you can multiply the final result by 100, which would give you 7.4% as the cash on cash return for the investment property in the example.
What does this mean?
This means that the property will be making a profit that is equal to 7.4% of the total cash invested in the property each year.
It is important to note that there are other methods for calculating the cash on cash return, and that the cash on cash return metric is best used for investment properties that are purchased using a mortgage or a loan. If the investment property was purchased 100% with cash, then the cap rate metric is a more suitable metric to use for the property valuation.
What Is an Investment Property Calculator?
An investment property calculator is a tool used in real estate investing for calculating the different types of cash on cash return with ease and in a short amount of time.
Instead of having to use a spreadsheet to manually calculate all the different values for one or more investment properties in order to get the cash on cash values for these properties, a investment property calculator allows real estate investors to conduct investment analysis with ease by inserting the different values separately, while the calculator does its work to modify the results based on the different variable and the adjustments that you make.
For example, the investment property calculator may be used to calculate the cash on cash return for an investment property that you intend to purchase using a 60% loan. However, if at any point you decide to use an 80% loan instead, you would only need to adjust the value of the loan, and the calculator will take care of the rest to give you the new result based on the new value of the loan.
Mashvisor’s investment property calculator takes into account all the different values, metrics, and expenses that may affect the final result of your calculation, and it allows you to customize and modify any of these values at any stage, or even add new values such as unexpected or unique expenses in the mix to give you the most accurate results.
Cash on Cash Return: Real Estate Investing
What Is Good Cash on Cash Return for an Investment Property?
Now that you know what the cash on cash return is, how to calculate it, and how an investment property calculator can help you calculate it with ease, you might be wondering: how do I know what’s good cash on cash return for an investment property?
The answer to that relies on your own preferences and experience as a real estate investor. Some real estate experts believe that good cash on cash return has to be any value above 8%, while others only consider properties that have a cap rate of 20% or above.
The amount of optimal cash on cash return can vary significantly based on the investor and the property, as well as the area that you’re investing in.
To decide on the cash on cash return that you would like to aim for, it is best to do market analysis to see the average cash on cash return value in the area and for properties of similar types, and try to aim for that average or higher in order to guarantee the return on investment for your purchase.
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To Sum Up
The cash on cash return is a very useful metric when conducting investment analysis in general, and property valuation in particular, as it gives you a very clear idea of the return on investment that you should expect to make from an investment property.
Despite cash on cash return being somewhat simple to calculate, the process of collecting data and calculating the different values for a number of different properties can be a very daunting and time-consuming task. For that reason, it is usually best to use an investment property calculator in order to achieve the most accurate results in the least amount of time.
Finally, if you want to learn more about the average cash on cash return for a specific city or neighborhood in order to decide on the best cash on cash return for your investment property, head over to Mashvisor and start searching the area of your choice, and you will be provided with all tools and data that you need, from the area’s averages, through the specific property’s cash on cash return, to a powerful calculator that can calculate cash on cash return, cap rate, and other values.
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