Real Estate Investment is a diversified field with so many metrics to understand how well your investment is doing in regards to the returns. Investors are constantly in search of the metrics that can provide a comprehensive understanding of the same. Out of all the metrics available, one of the crucial metrics is cash-on-cash return(CoC). In this blog, I will dive deep into what cash-on-cash return means for investors, its importance, how it differs from other return metrics, and why it holds significant weight in the world of real estate investment.
Understanding Cash-on-Cash Return
Cash-on-cash return is an essential metric that calculates the income earned on the cash invested in a property, usually on a pre-tax basis. This is a useful metric for investors who want to know the profitability of their investments without factoring in non-cash expenses such as depreciation. It measures the annual return received in comparison to the amount of mortgage paid in a single year. Cash-on-cash returns are used to set a goal for estimated returns and expenses.
Importance of Cash-on-Cash Returns
Cash-on-cash return is a significant metric for investors in various ways. It helps investors to make well-informed decisions by comparing multiple investment opportunities. It aids investors in deciding whether they should invest in an asset or not, after estimating the potential return on the capital invested. It is the quickest way of assessing the performance of an investment. Also, the calculation of the cash-on-cash returns metric is simpler than others.
Here is how to calculate the cash-on-cash returns:
Cash-on-Cash Return (%)=(Annual Pre-Tax Cash Flow/ Total Cash Invested)×100
Let’s break down the formula with an example. Suppose an investor purchases a property for $200,000 in cash and generates an annual pre-tax cash flow of $15,000. The cash-on-cash return would be calculated as follows:
Cash-on-Cash Return (%)=($15,000/$200,000)×100=7.5%
What is a Good Cash-on-Cash Return?
A good cash-on-cash depends upon various factors like risk tolerance, market conditions, and the investor’s financial objective. However, a higher cash-on-cash usually signifies a slightly higher risk. Additionally, it depends upon individual circumstances and the prevailing market conditions to state a good cash-on-cash return. Sometimes for an investor low cash-on-cash return is considered to be an excellent investment due to projected returns and lowered risk. So, it is not certain to state which cash-on-cash return is good, it depends upon various factors that are not certain and changes as per investor’s preferences and goals.
What does Cash-on-Cash Return mean for Real Estate Investment?
Cash-on-cash return is a key indicator for evaluating the financial performance of a real estate investment. A positive cash-on-cash return is indicated when an investment generates more cash than the capital invested, contributing to a profitable venture. Whereas the negative cash-on-cash return implies that the investment is not meeting the expected returns, suggesting investors should reevaluate their strategy or consider alternative investments. As far as cash-on-cash returns are concerned it is a tangible measure of profitability on an annual basis. By focusing on the initial invested amount and the projected returns investors can take a call about their portfolio, assess the impact of financing, and strategically allocate the resources to maximize returns.
Conclusion
In the dynamic world of investing where market conditions are not stable, every decision plays a significant role in financial implications and understanding. Utilizing metrics like cash-on-cash return is paramount. This metric helps investors measure the performance of the property, make informed decisions, compare various opportunities available in the market, and invest in an asset that aligns with their financial goals. In real estate, cash-on-cash return reigns supreme as a reliable source for measuring the success of an investment.