Introduction

Cash on cash return is a popular financial metric used by investors to evaluate the profitability and investment potential of income-producing properties such as real estate. The concept is simple – it helps investors understand what percentage return they can expect on the amount of cash invested in a certain property. This article will provide an easy-to-follow guide on how to calculate cash on cash return for your investment properties.

Step 1: Understand the Components of Cash on Cash Return

Cash on cash return is calculated by dividing the annual net cash flow from a property by the amount of initial cash investment. Here’s a look at each component:

1. Annual Net Cash Flow: It represents the total annual income generated from an investment property, minus all associated expenses, such as mortgage payments, maintenance costs, taxes, and insurance.

2. Initial Cash Investment: This includes any amounts spent towards purchasing the property or completing any necessary renovations or improvements before renting it out.

Step 2: Calculate Annual Net Cash Flow

To calculate annual net cash flow, follow these steps:

1. Determine Gross Annual Income: Calculate the total annual rent or income generated from the property.

2. Estimate Operating Expenses: Make a list of all expenses related to the property, such as maintenance, repairs, insurance, property taxes, and property management fees.

3. Subtract Operating Expenses from Gross Annual Income: Doing so will give you your net operating income.

Next, account for any mortgage payments associated with the property:

4. Calculate Mortgage Payments: If you have a mortgage on your investment property, note down your annual mortgage payments.

5. Subtract Mortgage Payments from Net Operating Income: The result shows your annual net cash flow after accounting for all expenses and mortgage payments.

Step 3: Calculate Initial Cash Investment

The initial cash investment includes funds required for purchasing and renovating the property before renting it out. Here’s how to calculate it:

1. Determine Purchase Price: Make a note of the purchase price of the investment property.

2. Calculate Down Payment: If you obtained a mortgage, multiply the purchase price by the down payment percentage you paid.

3. Estimate Closing Costs: Identify any fees associated with home inspections, appraisals, title searches, lender fees, and other closing costs and sum them up.

4. Account for Renovation and Improvement Costs: Calculate any expenses incurred for repairing or remodeling the property before it starts generating rental income.

Combine these costs together to arrive at your total initial cash investment.

Step 4: Calculate Cash on Cash Return

Finally, to calculate cash on cash return, divide the annual net cash flow by the initial cash investment:

Cash on Cash Return = (Annual Net Cash Flow) / (Initial Cash Investment)

Express this value as a percentage for easy comparison between potential real estate investments.

Conclusion

Cash on cash return is an essential metric that every real estate investor should know and understand. By following the steps outlined in this article, you can easily calculate this metric for your property investments and make informed decisions about their profitability. Remember to consider various factors when making an investment decision, including local market dynamics, rental demand, tenant quality, vacancy rates, and appreciation potential alongside cash on cash return figures. Happy investing!