Cash on Cash (CoC) provides an easy way for real estate investors to quickly compare the profitability of similar income-generating properties or evaluate it against another investment opportunity.
CoC, however, is not a particularly powerful tool for measuring the profitability of rental income property and currently receives less attention in real estate investment analysis than it used to receive a few years ago.
One shortcoming lies in the fact that cash back over cash does not take into account the time value of money. The cash-on-cash return should be limited to simply measuring the cash flow of the first year of a residential income property and not the cash flows of the future year.
Nonetheless, cash over cash is not without validity and still offers seasoned and novice real estate investors a benefit that has always been attributed to its popularity.
The CoC return measures the relationship between the first year’s anticipated cash flow and the amount of the initial cash investment made by the real estate investor to purchase the rental property. Therefore, CoC is always expressed as a percentage.
The “first year cash flow” (or annual cash flow) is the amount of money the property is expected to generate during the first year of operation. The “initial investment” (cash invested; sometimes called acquisition cost) is the total amount of cash invested, including the down payment, loan points, escrow and title fees, appraisal and inspection costs .
Okay, let’s start with an example and then let’s do the math.
Suppose you are interested in purchasing a property with six units, each paying $ 1,000 per month in rent. Estimate the first year’s operating expenses at $ 28,800. You are planning a new mortgage with a down payment of $ 126,000, loan points of $ 2,940, and a monthly payment of $ 1,956. You estimate your closing costs (escrow, title, inspections, and appraisal fees) to be $ 2,100.
Formula: Annual Cash Flow / Cash Investment = Cash Over Cash Yield
In this case, you will need to perform five calculations (to determine annual cash flow and cash investment) before you can calculate cash over cash.
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Annual rental income: (6 units x $ 1,000) x 12 = $ 72,000
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Net operating income (NOI; income less expenses): $ 72,000 – 28,800 = $ 43,200
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Annual debt service (mortgage payment): $ 1,956 x 12 = $ 23,472
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Annual cash flow (net operating income less payment): $ 43,200 – 23,472 = $ 19,728
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Cash investment (down payment + points + closing costs): $ 126,000 + 2,940 + 2,100 = $ 131,040
Calculation: (Annual cash flow / Cash investment = Cash over cash yield) $ 19,728 / $ 131,040 = 15.06%
Now that you know that this specific investment opportunity produces a 15.06% CoC return, you can compare it to similar properties or alternative investments, such as a T-Bill rate, and decide whether or not to proceed with a purchase.
