Cash on Cash Return on CRE is an essential concept for real estate investors to understand. Cash on cash return in real estate is used when comparing the income received from property against the amount of money invested into it.
This number can help you assess your investment and determine if you’re making enough profit to continue investing in that area.
It’s also helpful when considering buying another property because it helps give you an idea of how much overall profit will be received over time. There are several ways to calculate this number.
One method is by taking the total annual rental income and dividing it by the total amount spent on the down payment and closing costs (which includes costs any additional loans taken out). Keep reading below to learn more about this calculation.
What is the Cash on Cash Return Formula?
The cash flow before tax is divided by total equity invested. The formula uses the real estate proforma to determine cash flow before taxes. The first equity investment is the full purchase price less any loan proceeds and transaction charges, plus any additional equity required.
Given that pre-tax cash flow is included in the calculation, investors should understand their tax status. High taxes might wipe out modest cash on cash returns.
Let’s see an example of how you calculate cash on cash return. Let’s say you’ve decided to purchase a commercial space for $1,000,000. You paid $250,000 in down payment.
- Your annual revenue is $300,000.
- Subtract $125,000 mortgage.
- Subtract $150,000 in expenses.
Your total annual, before-tax cash flow is $25,000.
The next step in the computation is to:
- Divide your total cash invested, the $250,000 downpayment to your annual, before-tax cash flow of $25,000.
Your cash on cash return is 10%. In this case, the property would yield 10% cash-on-cash, this is a fantastic return, but it is not in other markets, like owning a trailer park.
The cash-on-cash return is a great way to measure your investment returns. However, it should be combined with other metrics, such as how much you’re making overall and what risks are involved.
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