What Is A Good Cash On Cash Return?
Rental property investors who are trying to determine the profitability of a property use a variety of different metrics to get a better understanding of how successful their investment is. While you may have read articles about how to determine the return on investment (ROI) of a property, that can be difficult to apply to rental properties. Instead, the cash-on-cash return of a property can give you a better understanding of the viability of your investment.
What is Cash-on-Cash Return?
Cash-on-cash return is the annual return on the investor’s investment (for the down payment + closing costs + renovation or any other CapEx such as roofs replacements)..
The formula for determining the cash-on-cash return on a property is simple to calculate:
Annual Cash Flow/Cash Invested
The cash invested portion of the equation includes every dollar you have invested into the property. Down payment, closing costs, loan costs, repairs, and other fees are all a part of the cash invested portion of the cash-on-cash return. Conversely, annual cash flow refers to all of the cash on hand after all of the expenses are paid.
Cash on hand is the amount of money you’re left with once you’ve paid for maintenance, trash collection, utilities, pest control, landscaping and any other expenses associated with the property you’re invested in.
Let’s take a look at an example of a cash-on-cash equation. A property produces annual cash flow of $500,000. You invested $2,000,000 in the deal which includes $1,500,000 for the down payment, $425,000 for renovations and $75,000 in closing costs. Cash-on-Cash return in this scenario would be equal to 25% ($500,000/$2,000,000)
What is a Good Cash-on-Cash Return?
If you asked 100 successful real estate investors about what a good cash-on-cash return is, you’d probably get dozens of different answers. Some investors won’t consider a property with a cash-on-cash return rate below 8%, while others only choose properties that boast a 20% cash-on-cash return. To determine what a good cash-on-cash rate is for you, you have to answer some questions about your goal for the investment.
First of all, you will need to determine how much you want to finance. The example we looked at earlier included an example where you financed 80% of the property’s total price. If you finance more or less than that number, your cash-on-cash return may increase or decrease.
Secondly, you will need to consider the competitiveness of the market you’re investing in. If you have found a property in a booming market and is projected to do so for years, it may be worth taking a lower cash-on-cash rate to get into a hot market and get some additional value in appreciation. But remember, appreciation is speculative, so you need to keep that in mind as well.
Finally, determining what a “good” or “bad” cash-on-cash return rate largely hinges on how long you plan on investing in the property. If you want to turn a profit quickly, you will need a property with a higher rate. If you’re willing to hold onto the properties for the long-term, a lower cash-on-cash return is acceptable.
The most important part of your investment is that you are able to get a positive return on every dollar that you invest. The speed at which you begin turning a profit may vary between investments. Determining what a good cash-on-cash return rate is for you is dependent on your personal investment strategy.
*Tip*: Once you decide what your Cash-on-Cash return requirement is, stick to it and stay disciplined when vetting your investments.