Cash on Cash Return

What Is a Cash on Cash Return?

A cash on cash return is a measure of the cash flow that an investment generates relative to the amount of cash invested. It is calculated by dividing the annual cash flow generated by the investment by the initial cash investment, and is expressed as a percentage.

For example, if an investment generates $5,000 in annual cash flow and the initial cash investment was $50,000, the cash on cash return would be 10% (5,000 / 50,000 = 0.10).

Cash on cash return is often used to evaluate the profitability of rental properties, as it provides a simple way to compare the cash flow generated by different properties.

It is also used to evaluate other types of investments, such as businesses or venture capital investments.

Cash on Cash Return – Key Takeaways

• Cash on cash return is the measure of an investment’s annual pre-tax cash flow divided by the total amount invested.
• It is a helpful metric for investors to determine whether their investments are meeting certain performance thresholds or not.
• The higher the cash on cash return, the more successful and profitable an investment can be considered to be.
• A number of factors can affect the rate of return, including rental income, expenses, mortgage interest rates, taxes, and appreciation potential among others.
• Cash on cash return should not be confused with other forms of returns such as capitalization rate or internal rate of return (IRR).

Calculating Cash on Cash Return

The formula for calculating cash on cash return is:

Cash on Cash Return = (Annual Cash Flow / Initial Investment) x 100%

For example, if an investment generates $10,000 in annual cash flow and the initial investment (i.e., upfront capital committed) was $50,000, the cash on cash return would be 20% (10,000 / 50,000 = 0.20; 0.20 x 100% = 20%).

It’s important to note that a high cash on cash return does not always indicate a good investment.

When evaluating potential investments it’s important to consider additional factors such as appreciation potential and liquidity before making an investment decision.

Sometimes cash on cash return can be high due to the use of leverage (i.e., something was bought with a lot of debt rather than committing equity or money that has been earned).

What Is a Good Cash on Cash Return?

The definition of a “good” cash on cash return can vary depending on a number of factors, such as the specific investment and the investor’s goals and risk tolerance.

In general, a higher cash on cash return is considered better than a lower one, as it indicates that the investment is generating more cash flow relative to the amount of cash invested.

However, it is important to note that the cash on cash return does not take into account the total return on an investment, which includes both the cash flow and any change in the value of the investment.

Therefore, it is not always accurate to compare the cash on cash return of different investments, as they may have different total returns.

In addition, the cash on cash return does not take into account the risk associated with an investment.

A higher cash on cash return may indicate that an investment is riskier, as it may be generating higher returns in order to compensate for the increased risk.

Cash on Cash Return vs. Cap Rate

Cash on cash return and cap rate are two different measures of the profitability of real estate investments.

Cash on cash return

Cash on cash return is a measure of the cash flow generated by an investment relative to the initial cash investment.

It is calculated by dividing the annual cash flow generated by the investment by the initial cash investment, and is expressed as a percentage.

For example, if an investment generates $20,000 in annual earnings/cash flow and the initial cash committed was $100,000, the cash on cash return would be 20% (20,000 / 100,000 = 0.10).

Cap rate

Cap rate, on the other hand, is a measure of the rate of return on an investment based on the income it generates.

It is calculated by dividing the property’s net operating income by the property’s value, and is expressed as a percentage.

For example, if a property generates $20,000 in net operating income and has a value of $400,000, the cap rate would be 5% (20,000 / 400,000 = 0.05).

Cash on cash return is often higher than the cap rate in real estate because properties are generally leveraged.

In sum, cash on cash return is a measure of the cash flow generated by an investment relative to the initial cash investment, while cap rate is a measure of the rate of return on an investment based on the income it generates.

How to Calculate Cash-on-Cash Return | Formula & Example

Cash on Cash Return in Venture Capital

Cash on cash return is also often used in venture capital investments as a measure of the returns generated by an investment relative to the amount of money invested.

It is calculated in the same way as it is for real estate investments, by dividing annual cash flows from the investment by the initial cash invested.

Venture capital investments tend to have higher cash on cash returns than real estate because they are generally riskier and require a higher rate of return in order to compensate for this additional risk.

Cash on Cash Return vs. ROI

Cash on cash return and ROI (return on investment) are two different measures of the profitability of investments.

Cash on cash return is a measure of the cash flow generated by an investment relative to the initial cash investment, while ROI is a measure of the rate of return on an investment based on its total returns, which includes both the capital gains realized from the sale of an investment and any income or dividends it generates.

Therefore, while they are related measures, they are not equivalent and should not be used interchangeably.

It is important to use both metrics when evaluating investments in order to get a full picture of their performance.

What Are the Flaws of Cash on Cash Return?

There are a few potential flaws with using cash on cash return as a measure of the profitability of an investment. Some of these include:

1. It only considers the cash flow generated by the investment, and does not take into account any changes in the value of the investment. This means that it is not always accurate to compare the cash on cash return of different investments, as they may have different total returns.
2. It does not take into account the risk associated with the investment. A higher cash on cash return may indicate that an investment is riskier and the return is being generated because of higher leverage. So it will need to be generating higher returns in order to compensate for the increased risk.
3. It is a simple, one-dimensional measure of profitability, and does not consider other factors that can affect the profitability of an investment, such as expenses, market conditions, and competition.

FAQs – Cash on Cash Return

Where is cash on cash return most frequently used?

Cash on cash return is most frequently used to evaluate the profitability of rental properties.

It provides a simple way to compare the cash flow generated by different properties, and is often used by real estate investors to determine the feasibility of a potential investment.

However, cash on cash return is not limited to real estate investments and can be used to evaluate the profitability of other types of investments as well.

For example, it can be used to evaluate the profitability of a small business or a venture capital investment.

What’s a good cash on cash return for a rental property?

The definition of a “good” cash on cash return for a rental property can vary depending on a number of factors, such as the location of the property, the state of the local real estate market, and the investor’s goals and risk tolerance.

In general, a higher cash on cash return is considered better than a lower one, as it indicates that the property is generating more cash flow relative to the amount of cash invested.

According to some, a good cash on cash return for a rental property is typically in the range of 10-12%.

However, it is important to note that this is just a general guideline and may not apply to all properties or all investors.

Real estate is generally leveraged, so cap rate is often the more common metric to get a gist of a property’s true earnings.

It is also important to consider that the cash on cash return does not take into account the total return on an investment, which includes both the cash flow and any change in the value of the property.

In addition, the cash on cash return does not take into account the risk associated with the investment.

A higher cash on cash return may indicate that the property is riskier, as it may be generating higher returns in order to compensate for the increased risk.

In the end, the decision of whether or not a particular cash on cash return is “good” should be based on the investor’s personal goals and risk tolerance.

What is the gross rent multiplier?

The gross rent multiplier (GRM) is a measure of the relationship between the price of a rental property and the annual rental income it generates.

It is calculated by dividing the price of the property by the annual rental income, and is often used to evaluate the feasibility of a potential rental property investment.

For example, if a rental property is priced at $500,000 and generates $50,000 in annual rental income, the gross rent multiplier would be 10 (500,000 / 50,000 = 10).

This indicates that the property is generating $1 in annual rental income for every $10 of the property’s value.

A lower GRM is better than a higher GRM because it essentially says you’ll get your money back sooner. It is similar to a P/E ratio for stocks.

The gross rent multiplier can be useful for comparing the relative value of different rental properties.

For example, if two properties have the same price but one has a higher gross rent multiplier, it may be a better investment because it is generating more rental income relative to its value.

However, it is important to note that the gross rent multiplier does not take into account other factors that can affect the profitability of a rental property, such as expenses, vacancy rates, and changes in the local real estate market.

Therefore, it should not be used as the sole basis for evaluating a rental property investment.

Conclusion – Cash on Cash Return

Cash on cash return is an important metric that should be considered when evaluating potential investments, but it should not be used in isolation as it does not take into account other factors such as appreciation potential or total return.