Along your multifamily investing journey, you’ll likely come across firms that tout their “cash on cash returns” in their case studies and portfolios.
Cash on cash return is a key ratio for real estate investors to compare the annual pre-tax cash flow to the initial equity contribution. This helps you evaluate the profitability and efficiency of an investment, and through that evaluate a firm’s choices.
In this article, we’ll explain what cash on cash return means, how to calculate it, and how to use it to make more informed investing decisions.
What is Cash on Cash return?
Cash on cash return measures the annual return on your cash invested in a property relative to the amount spent during the same year. This provides a straightforward way to determine how much cash flow a property is generating.
In other words, cash on cash return tells you how hard your money is working for you. It takes into account the upfront investment (downpayment and closing costs) along with any additional cash invested in the property. By calculating your cash on cash return, you can quickly assess whether a property is a good investment opportunity or not.
How to Calculate Cash on Cash Return
To calculate cash on cash return, you’ll need to know your annual pre-tax cash flow and your total cash invested.
Here’s the formula you can use to calculate cash on cash return:
Cash on Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested
Let’s break this down into two components:
- Annual Pre-Tax Cash Flow: This is the total income generated by the property minus all operating expenses (excluding mortgage payments). Operating expenses can include property taxes, insurance, repairs, property management fees, and vacancy costs.
- Total Cash Invested: This includes your down payment, closing costs, and any additional cash invested in the property for repairs or improvements.
Now let’s review a rather simplistic example:
Suppose a multifamily investment firm purchases a building for $2,000,000, puts $500,000 down, spends $50,000 in closing costs, and makes $100,000 in repairs. The total cash invested would be $650,000.
Now, suppose the property generates $300,000 in rental income each year and carries $150,000 in operating expenses. That gives it a net operating income of $150,000. Next, we need to subtract the mortgage payments and interest; we’ll keep it simple and assume this is $90,000.
That gives the property owner an annual cash flow of $60,000. Based on this, we can calculate the cash-on-cash return:
Annual cash flow / Cash invested x 100, $60,000 / $650,000 * 100 = 9.2%.
Read on as we show you what’s realistic to expect for a cash on cash return, and how to use this metric to compare multifamily offerings.
What is a Good Cash on Cash Rate of Return
So, what is considered a good cash on cash return?
The answer depends on several factors including:
- The location of the property
- The asset class
- Your investment goals
If you Google “average cash on cash return” you might end up with a figure of 8-12%. Many of these averages are based on single-family or smaller multifamily properties that tend to have lower expenses.
A larger property (of say, 50 or more units) will have higher maintenance costs as a result, and may result in a cash on cash return of 7 9%. It’s not that the smaller properties are objectively better, this is just something that you should consider and bear in mind when comparing real estate investment opportunities.
It’s important to remember that cash on cash return is just one metric to consider when evaluating a real estate investment. You should also look at factors such as the property’s location, the strength of the rental market, and the overall economic outlook for the area.
Cash on Cash Return Compared to Other Metrics
Cash on cash return is not the only metric that multifamily firms will share to illustrate the success of their investment decisions. There are two other that cash on cash return gets grouped in with:
- ROI
- IRR
Cash on Cash Return vs ROI
While cash on cash return and return on investment (ROI) are both used to evaluate the profitability of an investment, they are calculated differently.
ROI measures the total return on an investment, including appreciation, over a period of time. It takes into account all cash flows, including the appreciation and sale of the property.
On the other hand, cash on cash return only considers the return on the actual cash invested in a property and does not include mortgage financing or property appreciation. It’s a more immediate measure of an investment’s performance.
Cash on Cash Return vs IRR
Internal rate of return (IRR) is another metric used to evaluate real estate investments. Like ROI, IRR takes into account all cash flows over the life of an investment, including the sale of the property.
However, IRR also considers the time value of money, which means it accounts for the fact that money received in the future is worth less than money received today. IRR can be a bit tricky to understand or calculate for novice investors, so we created an IRR calculator to help illustrate how it influences your return,
Cash on cash return, in contrast, is a simpler metric that focuses solely on the cash flow generated by a property in a single year, relative to the cash invested.
Download the Multifamily Investing Guide
Cash on cash return is a critical metric for real estate investors to understand and utilize in their investment decisions. By calculating the annual return on your cash invested, you can quickly assess the profitability and efficiency of a property.
By understanding cash on cash return, you will be able to better compare and evaluate the cash flow potential of multifamily investments. There’s much more to multifamily investing than this though, so we encourage you to download our free multifamily investing guide. In this guide you’ll learn:
- The tax benefits of investing in multifamily real estate
- Your options for investing in multifamily real estate
- How to evaluate firms
And more. Fill out the form below to download your guide.