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What is Cash on Cash Return in Real Estate?

Cash on cash return: Cash in a small briefcase with cash on the table.
Understanding cash on cash return is useful for investors to evaluate the profitability of a property.

Cash on Cash Return Defined

Cash on cash return (or COC) is a financial tool for checking if a property is a good investment. It shows how much money you’ll make each year based on how much money you put in at the beginning. By analyzing both the cash inflow and the initial investment, cash on cash return provides valuable insights into the profitability of a real estate investment.

While COC return is a nifty way to check if a property is worth investing in, but it doesn’t tell the whole story. It only tells you how much money you’ll make based on how much you put in. COC return does not include other factors such as tax breaks, equity growth, or the value going up over time. That’s why it’s smart to use other metrics too when deciding if a property is a good investment. By looking at all the financial implications, you can make a smart choice about whether to invest or not.

Cash on Cash Return Calculator

If you want to know the cash on cash return for a property, you need two things. First, find out how much cash the property makes each year before taxes and debt service. This is called the annual pre-tax cash flow, and you get it by subtracting the debt service from the net operating income. Second, add up all the cash you put into the property, like the down payment, closing costs, and any renovation costs. That’s the total cash invested. Once you have both numbers, you can figure out the COC return.

The calculation for COC return is this: Take the annual pre-tax cash flow and divide it by the total cash invested. That gives you the percentage of COC return. So if you have an annual pre-tax cash flow of $10,000 and a total cash invested of $100,000, your cash on cash return is 10%.

The cash on cash return is handy but, it doesn’t consider things like the property’s value going up, tax breaks, or equity growth, which are also important. That’s why it’s smart to use other metrics too when deciding if a property is worth investing in. There are also investments strategies such as BRRRR that might be a good fit if you plan to scale your real estate business quickly.

CAP Rate vs Cash on cash Return

Woman calculating cash on cash return.
A higher capitalization rate generally indicates higher returns, while a lower rate indicates potentially lower returns.

We just discussed COC return, now let’s take a look at CAP rate.

CAP Rate (Capitalization Rate) is all about how much money a property can make compared to its value. To find out the CAP Rate, you divide the property’s net operating income (NOI) by its market value. The number you get is the percentage of return you’d make if you bought the property with cash and didn’t take out a mortgage. CAP Rate is good for comparing different properties and seeing if you can make money from them.

The difference between the two: CAP Rate measures the performance of a property relative to its value, while COC return is about how much cash you’ll really get back. They’re both useful when you’re deciding whether to invest in real estate. But remember, you should use them with other financial metrics to make smart choices.

What is a Good Cash on Cash Return?

The best cash on cash return for a real estate investment isn’t set in stone. It depends on a few different things, like where the property is, what type of property it is, and how you plan to invest. The higher the % the better, but it’s also very market specific. For example, an investor in California might be ok with a 6% COC return rate but an investor in Ohio might look for something over 10%.

In terms of an average, a lot of investors hope for a cash on cash return of around 8-12% every year. But what’s “good” really depends on the investment and what the investor wants to get out of it.

Just remember, Cash on Cash Return is just one of many metrics you should use when evaluating a rental property investment. Location, market rents, vacancy rates and potential appreciation should all be considered as well. If the property needs significant renovations, this should also be taken into consideration and be reflected in your offer price.

Summary

Cash on cash return is a useful tool for figuring out if a real estate investment will make you money. It measures the annual return on your initial cash investment, giving you an idea of how profitable your investment will be. There’s no set COC return rate that’s right for everyone, but it’s important to aim for a return that exceeds your expected rate of return and takes into account the risks associated with the investment. If you understand and use cash on cash return, you’ll be able to make smarter investment decisions and improve your overall performance as a real estate investor.

Related: How Many Rental Properties Does it Take to Retire?

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