Cash on cash return is a straightforward metric that real estate investors use to evaluate the profitability of their investments. Its simplicity and how to calculate cash on cash return make it appealing for those looking to assess the income potential of a property relative to the amount of cash invested.
Let’s break down the concept and benefits of calculating cash on cash return using your own numbers.
Understanding Cash on Cash Return
Cash on cash return measures the annual pre-tax cash flow generated by an investment property in relation to the total cash invested. Unlike other metrics, which often include non-cash transactions or focus on overall return on investment, cash on cash return only considers actual cash flow, making it a highly relevant metric for investors who prioritize liquidity and short-term returns.
The formula is simple to apply:
Cash on Cash Return = (Annual Pre-Tax Cash Flow ÷ Total Cash Invested) × 100
The numerator, annual pre-tax cash flow, represents the income the property generates after operational expenses but before taxes. The denominator, total cash invested, includes your down payment, closing costs, and any additional cash contributions made to the property.
Benefits of Calculating Cash on Cash Return
Calculating cash on cash return offers actionable insights that can shape how you select and manage investment properties. Here’s why putting your own numbers into this calculation is crucial for smart investing decisions.
Provides Realistic Investment Insights
Using your own financial figures ensures that the cash on cash return calculation reflects your unique investment situation. This realistic perspective eliminates the guesswork and helps you make data-driven decisions tailored to your financial goals.
For instance, if two properties appear equally appealing on paper, calculating the cash return for each using your own expenses can reveal which offers better immediate returns and aligns more closely with your cash flow objectives.
Empowers Better Decision-Making
Evaluating potential investments based on cash on cash return can help you compare opportunities effectively. You gain a clear understanding of which property generates stronger cash flow relative to your investment. This ensures that you’re not just swayed by overall appreciation potential, which often takes years to materialize, but also by the income you’ll earn immediately.
Sharpens Your Financial Planning
When you calculate cash on cash return with your own numbers, you’re forced to account for all your expenses and potential income. This process aids in creating more accurate financial projections. You not only measure profitability but also get a clearer picture of how much cash you’ll have on hand to reinvest or cover unforeseen costs.
Simple Yet Effective
The simplicity of the cash on cash return formula makes it accessible, even if you’re new to real estate investing. You don’t need advanced financial tools or software to run this calculation; just basic income and expense data will suffice. This accessibility allows you to analyze properties quickly, helping you decide where your money yields the best results.
Encourages Cash-Flow Focus
By using cash on cash return, you stay attuned to the importance of positive cash flow. Investments with strong returns often indicate healthy financial stability, reducing the risk of relying on external funding for operational issues or emergencies.
Applying the Metric to Maximize Results
To make the most of cash on cash return, use this calculation throughout various investment stages. Apply it during the property evaluation stage to sort out options with strong cash flow potential. Revisit the calculation periodically after the purchase to track performance and implement necessary adjustments.