What’s cash-on-cash return in real estate?

Cash-on-cash return is a practical way to gauge how much income a real estate investment might generate. It’s a straightforward metric that gives investors quick insight into year-over-year performance in deals that involve financing.

In this article, you’ll find out what cash-on-cash return is, how to calculate it, and how it compares to other common metrics like return on investment (ROI) and cap rate.

What does cash-on-cash-return mean?

In real estate, cash-on-cash return measures how much pre-tax cash flow a property produces in a year relative to the cash invested by the buyer. It only focuses on actual out-of-pocket cash — this means expenses like your down payment, closing costs, and upfront improvements. It’s particularly useful in commercial real estate deals where a portion of the purchase is financed with debt.

Cash-on-cash return is also known as cash yield in some investing circles. It offers a simple way to estimate how much income your equity is generating without factoring in appreciation or loan paydown. For real estate investors, it’s a tool that helps measure short-term income performance instead of long-term gains.

When financing is involved, cash-on-cash return becomes even more important. Two investors could buy the same property at the same price and get drastically different cash-on-cash returns depending on how much they contribute up front. Lowering the cash invested, like by choosing a smaller down payment or negotiating lower closing costs, improves your return even if cash flows stay the same.

Cash-on-cash return is also often used in partnerships. If you’re bringing in investors who want to see a transparent annual return on their equity invested, the cash-on-cash return projection becomes a key part of the pitch.

How’s cash-on-cash return used in real estate?

Cash-on-cash return is popular among real estate investors because it shows how efficiently their money is being put to work. It’s a solid starting point for evaluating investment properties and estimating cash flows before and after debt.

Say you’re considering two properties with similar prices but different financing terms. Cash-on-cash return shows you which one delivers a better return on your actual cash invested, even if the gross income looks the same.

Investors also use cash-on-cash return as a way to align with specific income goals. For example, someone aiming for a minimum 10% annual return on their equity invested can use a cash-on-cash return as a litmus test before digging into more detailed underwriting.

Beyond deal screening, cash-on-cash return is often used to:

— Estimate how much income a property might generate in future years

— See how loan payments on the property impact the cash you actually take home

— Figure out how to split profits fairly in partnerships

— Compare different properties, even if they’re in different cities or have different price points

It’s one of several metrics used together, alongside ROI, cap rate, and internal rate of return (IRR), to draw a full picture of real estate investing performance.

This kind of snapshot is also helpful when you need to make an offer. If you’re bidding on a property or negotiating with partners, a cash-on-cash return estimate can show whether a deal meets expectations before you dive into the more complicated math.

How do you calculate cash-on-cash-return?

To run the numbers, you’ll need two things: your yearly pre-tax cash flow and your initial cash investment. The cash-on-cash return formula looks like this:

Cash-on-cash return = Annual pre-tax cash flow / Total cash invested

Start with pre-tax cash flow. Add up your gross rental income and any other income you expect to receive from the property. Subtract vacancy losses, operating expenses, and annual mortgage payments.

Then, add up your total cash invested. This usually includes your:

— Down payment

— Closing costs

— Upfront capital expenditures, like renovations or repairs

Cash-on-cash return example

You purchase a commercial real estate property for $2 million. You contribute $400,000 as a down payment, spend $25,000 on closing costs, and invest $25,000 on initial upgrades. That brings your total cash invested to $450,000.

Over the next 12 months, the property generates $180,000 in rental income. After accounting for $20,000 in vacancies, $50,000 in operating expenses, and $60,000 in debt service, your annual pre-tax cash flow is $50,000.

Using the cash-on-cash return formula, we get:

$50,000 / $450,000 = 11.1% cash-on-cash return

This tells you the property generates an 11.1% return on your personal cash in the first year. That’s before taxes and without including any property value appreciation or paying down the loan principal.

What’s a good cash-on-cash return?

There’s no single number that qualifies as “good,” but some investors aim for a cash-on-cash return between 10% and 12%. In competitive or low-risk markets, a lower return might still be acceptable. In emerging markets or high-risk deals, expectations may rise higher than 12%.

What qualifies as a solid return depends on your risk tolerance, financing strategy, and investment goals. Lower upfront costs or favorable terms can raise your cash-on-cash return even if the property’s gross income remains the same.

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Cash-on-cash return vs. other metrics

Cash-on-cash return gives investors a focused view of income, but it’s even more helpful when used alongside other metrics. Here are some of the most useful.

Cash-on-cash-return vs. ROI

ROI looks at total returns over the full life of an investment. It includes appreciation, equity buildup through paying down loan principal, and eventual proceeds from a sale.

Cash-on-cash return looks only at current pre-tax income in relation to the cash invested. It doesn’t include profits from appreciation or principal repayment. Also, unlike ROI, it’s usually measured over a one-year timeframe. While ROI is helpful for assessing total performance, cash-on-cash return is better for measuring how much net cash flow you’re getting from your equity right now.

Cash-on-cash-return vs. cap rate

You can calculate the capitalization rate, or cap rate, by dividing a property’s net operating income by its market value. This metric ignores any previous financing.

Cash-on-cash return, on the other hand, accounts for any mortgage payments and uses actual cash invested rather than market value. When you purchase a property in cash, cap rate and cash-on-cash return might look similar. But when financing is involved, cash-on-cash return gives a more personalized view of what the investor is earning.

In practice, real estate investors may use cap rate to compare investment properties at a market level and cash-on-cash return to understand the impact of their unique financing terms.

Cash-on-cash return vs. IRR

While cash-on-cash return focuses on yearly cash income based on your initial investment, IRR looks at the bigger picture. It measures your total expected return over time, including both the cash you receive each year and the profit you might make when you sell the property.

IRR takes into account the timing of those cash flows, which makes it more complex but also more comprehensive. It’s useful when you’re comparing long-term deals or projects with uneven income. That might be a renovation that generates little cash at first but more later on.

So, where cash-on-cash return gives you a quick snapshot of annual income, IRR helps you understand the full return over the life of the investment. Some investors use both: cash-on-cash return to track performance now, and IRR to evaluate long-term potential.

Boost your returns with smarter financing

Cash-on-cash return offers a clear, practical way to evaluate income performance based on the cash you’ve put into a property. For any investor focused on cash flow, it’s a metric worth understanding and tracking regularly.

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