How to Calculate Cash on Cash Return for More Informed Offers
When it comes to real estate investing, evaluating potential returns is crucial to making smart decisions. One popular metric for understanding investment performance is how to calculate cash on cash return. This measurement provides insight into the profitability of an investment relative to the cash invested and can be a game-changer for making more informed offers. Here’s a closer look at how to calculate it and why it’s such a valuable tool for investors.
What Is Cash on Cash Return?
Cash on cash return is a simple formula that calculates the annual cash income earned on the actual cash investment in a property. It’s expressed as a percentage and provides a clear picture of how well the investment is performing relative to the capital put into it. Unlike other complex metrics, this calculation focuses solely on the returns from cash invested, making it especially practical for evaluating ongoing cash flow.
The formula is straightforward:
Cash on Cash Return = Annual Pre-Tax Cash Flow ÷ Total Cash Invested
Understanding this formula allows investors to better gauge whether a property will meet their financial goals.
Why Is Cash on Cash Return Important?
- Quick Assessment of Profitability
Cash on cash return simplifies the evaluation process by offering a direct way to assess an investment’s profitability. Investors can quickly determine if a potential property aligns with their desired return goals without needing extensive calculations.
- Helps Compare Multiple Investments
This metric is particularly helpful for comparing various investment opportunities. With a consistent formula, investors can easily analyze properties side by side and identify which offers better cash flow relative to the cash invested.
- Focuses on Real Cash Flow
Cash on cash return focuses exclusively on the actual money entering your pocket. It disregards non-cash factors like depreciation, simplifying the evaluation to real, tangible returns. This makes it especially practical for individuals seeking cash-positive investments.
- Enhances Offer-Making Decisions
For investors unsure of how much to offer on a property, cash on cash return can guide their decision-making. By running different purchase price scenarios through the formula, you can determine the most viable and profitable offer without risking overpayment.
- Aids in Setting Investment Goals
This metric helps establish clear goals for return on investment. By calculating the percentage return, investors can decide on targets that align with their financial aspirations and measure progress objectively.
Steps to Calculate Cash on Cash Return
- Gather the property’s annual pre-tax cash flow. This includes income like rental payments minus expenses, excluding taxes or mortgage interest.
- Determine your total cash invested, including down payments, closing costs, and any initial repairs or renovations.
- Divide the annual pre-tax cash flow by the total cash invested, then multiply by 100 to convert it into a percentage.
For example, if the annual pre-tax cash flow is $15,000 and the total cash invested is $150,000, the cash on cash return would be:
$15,000 ÷ $150,000 = 0.10 or 10%
Making Cash on Cash Return Work for You
Calculating cash on cash return is an invaluable practice for any real estate investor. By focusing on the real cash flow generated by an investment and comparing it against the capital invested, you can make smarter, data-driven decisions. This simple formula transforms complex investment prospects into understandable opportunities, giving you a critical perspective for more informed offers.
