Cash-on-cash return is one of the best metrics to evaluate real estate investments. While there are many ways to build wealth through real estate, reliable monthly income is one of the most exciting reasons to own rental properties. By calculating cash-on-cash return (CoC), you can get a clear picture of whether your expected cash flow is worth the investment.
How to Calculate Cash-on-Cash Return
Math! I promise it won’t be too bad.
Your annual cash flow is how much cash you actually receive each year. Start with revenue and subtract all of your expenses.
- Revenue is typically just rent, but can also include laundry facilities, tenant utility reimbursement (RUBS), and leasing parking spots to residents.
- Expenses include taxes, insurance, property management fees, and mortgage payments.
The total investment includes your down payment, closing costs, and rehab budget — anything out-of-pocket when you purchase the property.
So, the two ways to boost your CoC return are (1) increase annual cash flow (earn more) or (2) reduce your total investment (pay less).
What Are Closing Costs?
Before we jump into a couple of examples, we need to discuss closing costs, which are fees paid to close the deal. You should include closing costs when calculating your total amount invested.
Closing costs may include the following:
- Loan origination fees
- Loan processing fees
- Title company fees
- Appraisal fees
- Notary fees
Fees fees fees.
You may also choose to “buy down the interest rate,” which means you pay more fees — called “points” — to reduce the interest rate.
(I think calling them “points” is somewhat silly. It makes them seem so happy. Points! Let’s earn some points by paying more fees! Ok, I’ll get back on topic. Apologies for the digression.)
Let’s work through some examples.
Cash-on-Cash Example
Let’s say you’re considering buying a single-family home worth $160,000.
Annual Cash Flow
You can expect $1,400 in rent each month — that’s $16,800 per year of revenue.
Taking into account insurance, taxes, management fees, repairs, and mortgage payments, the house has $12,800 per year of expenses.
When you subtract expenses from revenue, you end up with $4,000 of annual cash flow.
Total Investment
Now that we know the annual cash flow, we need to determine the total investment.
Assuming you can get a loan for 75% of the purchase price, you’ll need to come up with a 25% down payment, or $40,000 (25% of $160,000).
But that’s not all. Your closing costs (including points!) will be $6,400, and you expect to spend $3,000 for a light renovation to make the property more attractive to prospective tenants.
As a result, your total investment is $49,400 ($40,000 + $6,400 + $3,000).
The Final Calculation
Now, we divide the annual cash flow ($4,000) by the total investment ($49,400), which tells us the cash-on-cash return is 8.1%.
That means the annual cash flow will provide you with an 8.1% return on your investment — not bad! When you consider the other ways real estate helps build wealth (appreciation, principal paydown on the mortgage, and tax benefits), the returns are even greater.
How Does Cash-on-Cash Return Compare With the Cap Rate?
In a previous article, we discussed real estate cap rates, a useful metric for evaluating potential investments. The cap rate is calculated by dividing the net operating income of a property by its value.
While cap rates are great, they fail to account for leverage — taking on debt to purchase a property.
Financing a real estate purchase with a loan is a popular strategy because it allows you to control a larger asset while only putting up part of the cash. In the example above, an investment of $49,400 was enough to purchase (and renovate) a $160,000 property.
For many investors, cash-on-cash return is a more useful metric because it gives a clear picture of your return on investment, including closing costs, rehab expenses, and leverage.
What Is a Good Cash-on-Cash Return?
Whether the CoC return is good or bad depends on your investment strategy. Some investors won’t touch properties that offer below a 12% cash-on-cash return. Others may be fine with a CoC return of just 4% for new construction in an appreciating market.
As a general rule, higher-risk properties offer higher cash-on-cash returns. Some markets (like the midwest and southeast United States) also tend to offer better CoC returns than large cities in coastal markets. There’s no magical CoC threshold — it’s all up to you.
Any Questions?
If you have any questions about cash-on-cash return, forming a legal entity for your properties, or real estate investing in general, feel free to reach out. I love real estate investing.
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