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Cash on Cash Return

Guide to Understanding the Cash on Cash Return

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Cash on Cash Return

How to Calculate Cash on Cash Return (Step-by-Step)

The cash on cash return, or “cash yield”, measures a real estate investor’s annual pre-tax earnings on a property relative to the initial amount spent to purchase the property itself.

The cash on cash return is calculated as the ratio between:

  1. Annual Pre-Tax Cash Flow: The annual pre-tax cash income generated on the property investment.
  2. Invested Equity: The initial equity investment, i.e. the outlay of cash on the date of purchase.

In practice, the return metric estimates the annual yield received by an investor on a specific property relative to the amount paid in the corresponding year, e.g. the mortgage payments.

Cash on Cash Return Formula

The formula for calculating the cash on cash return involves taking the annual pre-tax cash flow and dividing it by the initial cash investment, i.e. the equity contribution.

Cash on Cash Return = Annual Pre-Tax Cash Flow ÷ Invested Equity

While the numerator is pre-tax, the metric is calculated post-financing, so the annual cash flow is a “levered” metric.

The CoC return metric is expressed as a percentage, which makes comparisons across different property investment opportunities easier. But per usual, the context in which the investment was completed such as the location, date and real estate market conditions must all be taken into consideration.

Common examples of expenses that are factored into the cash flow metric are the following:

  • Property Taxes
  • Maintenance Fees
  • Property Upgrades
  • Renovation Fees
  • Closing Fees
  • Insurance Premiums

Cash Yield vs. Return on Investment (ROI)

By now, we understand that the cash yield measures the annual pre-tax cash flow compared to the initial amount of cash invested.

In contrast, the return on investment (ROI) calculates the yield across the entire holding period, whereas the cash yield usually covers the current period, i.e. only one year.

  • Return on Investment (ROI) → Entire Holding Period
  • Cash Yield → Current Period, i.e. Twelve Months

The cash yield can be thought of as the return over a short time frame, while the return on investment (ROI) is a cumulative returns metric.

Unlike the return on investment (ROI), the cash yield can increase (or decrease) periodically due to fluctuations in rental income, expenses, and other related external factors.

Another differentiation between the two metrics appears when it comes to the topic of debt service. The cash flow metric in the CoC return calculation is only reduced by the debt service in the current period.

But the return on investment (ROI) metric considers the entirety of the debt obligations related to the property investment. Hence, the cash yield metric is most applicable for real estate property investments funded by debt capital.

If debt financing was used as part of the transaction – which is usually the case in the commercial real estate market – the actual cash return on the investment diverges from the return on investment (ROI).

What is a Good Cash on Cash Return?

There is not necessarily a “good” cash yield return that all real estate investors target considering each investor sets their own return (and risk) targets.

However, the real estate market consensus is that a forecasted cash-on-cash return between 8% to 12% is considered a worthwhile investment.

The market conditions are another factor that must be considered, as well as the type of properties (and geographical location) of the investments made.

For these reasons outlined above, it is difficult to quantify a specific, universal return to target, as it is subjective and affected by numerous variables.

Cash on Cash Return Calculator – Excel Template

We’ll now move on to a modeling exercise, which you can access by filling out the form below.

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Step 1. Commercial Real Estate Property Gross Income Calculation

Suppose a commercial real estate investor purchased a rental property with a potential gross income of $100,000. But because of vacancies and credit losses, there is a deduction of $25,000.

The effective gross income is thus $75,000.

  • Potential Gross Income = $100,000
  • Vacancy and Credit Loss = $25,000
  • Effective Gross Income = $100,000 – $25,000 = $75,000

Step 2. Net Operating Income Calculation (NOI)

Next, we’ll assume the operating expenses related to the property amounted to $30,000, so the net operating income (NOI) is $45,000.

Step 3. Mortgage Payments and Annual Pre-Tax Income Calculation

We’ll now subtract the debt-related payments for the current year – i.e. the mortgage payments such as interest and principal repayment – which we’ll assume to be $20,000.

  • Mortgage Payments = $20,000

By subtracting the rental property’s mortgage payments from its net operating income (NOI), we calculate the annual pre-tax income as $25,000.

  • Annual Pre-Tax Income = $45,000 – $20,000 = $25,000

Step 4. Cash on Cash Return Calculation Example and Yield Analysis

In the final section of our exercise, the only remaining assumption needed is the initial amount of equity invested, or $200,000.

  • Equity Invested = $200,000

After dividing our annual pre-tax cash flow by the equity invested, the implied return comes out to 12.5%.

  • Cash Yield = $25,000 ÷ $200,000 = 12.5%

Cash on Cash Return Calculator

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