If you’ve been thinking about investing in real estate, it’s likely you’ve come across terms like ROI, cap rate, and cash flow. But have you ever heard of cash-on-cash return?
But have you ever heard of cash-on-cash return?
To calculate your investment property’s return on investment (ROI) you have to know a few things. First, you must know how much money you initially invested in the property. Next, you need to know the total amount of money you’ve made off that property.
That said, it’s impossible to calculate the ROI on an investment property until after it’s been sold. Only then will you know the exact amount of money you made off that property and be able to calculate the true ROI.
Because of this, many seasoned real estate investors instead focus on cash-on-cash return, which can be calculated without selling the property.
To get a better idea about how profitable your investment property is (or will be), even if it’s your first one, you should learn about cash-on-cash return. And if you don’t know where to start, start here. We’re going to explain what cash-on-cash return means and why it matters.
What is Cash-on-Cash Return?
Cash-on-cash return (CoC) is one of the easiest to understand real estate metrics. This makes it especially helpful for those who are preparing to buy their first investment property.
In simple terms, cash-on-cash return is the money you’ve earned on the cash you’ve invested in an investment property. But there’s more to it than that. Cash-on-cash return is the money made on an investment property in relation to the amount of mortgage (and other expenses) paid during the year.
In other words, CoC return is a way to measure how hard your cash is working for you. It's also a way to gauge how successful your investment is and will be in the future.
Calculating cash-on-cash return is pretty easy:
Cash-on-Cash Return = Net Operating Income/Total Cash Investment
The net operating income is the annual pre-tax income you collect on the property, minus operating expenses. Operating expenses include maintenance and repairs, property taxes, HOA fees, and insurance premiums.
The total cash investment is the amount of cash you placed into the investment initially. For example, the amount of cash you paid, loan fees, closing costs, and initial rehab costs.
To makes things clearer, we’ll show you two cash-on-cash return calculations.
CoC Return Example: No Loan, All Cash Payment
The first CoC return example we’ll share is one in which you buy a rental property in MN for all cash.
- Property Price: $250,000
- Closing and Rehab Costs: $12,500
- Monthly Rent: $2,100 ($25,200 annually)
- Annual Operating Costs: $16,800 (two thirds of the annual rental income)
Using these numbers, we find that the net operating income is $16,800. The total cash investment is $250,000 + $12,500, or $262,500.
The cash-on-cash return is thus 6.4%.
CoC Return Example: With a Loan
The next CoC return example we’ll share is one in which you buy a rental property in MN with the help of a loan.
- Property Price: $250,000
- Down Payment: 25% ($62,500)
- Debt Service (8%): $15,000 ($187,500 x 8%)
- Closing and Rehab Costs: $12,500
- Monthly Rent: $2,100 ($25,200 annually)
- Annual Operating Costs: $16,800 (two thirds of the annual rental income)
Using these numbers, we find that the net operating income is $16,800 – $15,000, or $1,800. The total cash investment is $62,500 + $12,500, or $75,000.
The cash-on-cash return is thus 2.4%.
For those of you that don’t want to hassle with math, check out this handy cash-on-cash return calculator.
Why CoC Return Matters
Calculating the cash-on-cash return matters for many reasons:
- It measures the amount of cash flow you receive in relation to the amount of cash you invest
- It works for the current period (usually one year), as opposed to the life of the investment
- It’s a dynamic forecasting tool that can be used to project earnings, expenses, and success
Lastly, cash-on-cash return gives beginner real estate investors a great way to compare properties before making a purchasing decision.
What is a Good Cash-on-Cash Return?
There’s a lot of debate surrounding what makes up a “good” cash-on-cash return. That said, most investors will agree that a good CoC return lands between 8 and 12 percent.
But remember, cash-on-cash return isn’t the end all real estate investment metric. It’s only one of many that help you determine whether a property is worth investing in.
Adding to that, it is not recommended you rely on your cash-on-cash return calculations past the first 12 months of owning an investment property. As you pay down the loan and your expenses fluctuate, you’ll find your CoC return isn't as accurate.
That’s why, no matter what you decide is a good cash-on-cash return value, you should only use it to:
- Decide whether an investment property is worth buying
- See how hard your initial cash investment is working for you the first year
Not happy with the CoC return you calculated for your first investment property? Use it as a guide for the next property you buy so you can grow your portfolio with profitable properties that will generate the income you want.
How to Improve the Cash-on-Cash Return
Here are some ways to improve the CoC return of any rental property you buy:
- Low Interest Rate: if you are financing an investment property, make sure to secure the lowest interest rate possible. This will save you money in the long run and help improve the CoC return.
- Reduced Down Payment: sometimes when you’re just starting out, it's hard to come up with a large down payment. If you can convince the lender to let you lower the down payment, your CoC return will increase. Doing this will also lower your annual earnings, but it also means your cash is working harder for you. For those that don’t have a lot of cash to spend upfront, sometimes this is the best option. If you find it difficult to get approved by traditional lenders, be sure to check out other financing strategies such as seller financing.
- Eliminate Expenses: by working hard to lower your annual expenses, you can increase the CoC return and turn a higher profit. For example, lower vacancies, avoid problem tenants, and offer amenities (and increase the rent) to lower costs.
Lastly, aim to find low cost deals on investment properties. The less money you spend on a rental property, the more money you stand to make in the end. This is why having the knowledge and experience to find great property deals is so important.
Final Thoughts
Are you ready to buy your first investment property and want a high cash-on-cash return, as well as a strong ROI over the course of owning a rental property? Then check out our My First Deal Done in 60 Days training program.
We can teach you all about things like positive cash flow, return on investment, and cash-on-cash return. But more than that, we can give you the knowledge and tools needed to find great property deals that will ensure your success as a real estate investor no matter how new you may be.
Knowing how to set yourself up for success comes long before you ever buy your first rental property. Let us help you learn the ropes so you go into your first deal with the confidence needed to turn your life around.