Why Should YOU Understand Cash-on-Cash Returns?

Why Should YOU Understand Cash-on-Cash Returns?

Why Should YOU Understand Cash-on-Cash Returns?

What Does ‘Cash-on-Cash’ Mean?

Cash-on-cash return, also referred to as a property’s cash yield, compares a property’s earnings to the original cash investment over a set time (most often, annually). Cash-on-cash calculations are impacted by your financial obligations such as your mortgage, operating expenses, and vacancy losses, and are an important tool for measuring the value of your investment.

Why Would You Want to Know our Cash-on-Cash Calculation?

In the current market, it has become incredibly difficult to measure whether an investment decision will be profitable, both short- and long-term. Investors arm themselves with as many meaningful tools as they can, so that they take the least amount of risk for the highest possible return, and the cash-on-cash metric is a strong weapon to utilize in the current climate. ROI calculations, interest rate comparisons, market analyses, and all the standard tools used to measure the viability of an investment, have become more complicated and harder to assess during this inflation spike. Cash-on-cash is a metric you can quickly calculate, gives you a solid understanding of how fast you will be recouping your investment, and how quickly you will begin to turn a net profit.

How do you Calculate Cash-on-Cash Returns?

Cash-on-Cash return is calculated using a simple formula:

NOI

÷

Initial Cash Investment

NOI is a property’s Net Operating Income. NOI is calculated by taking the annual gross operating income of the property, and subtracting your annual expenses (mortgage payments, operating expenses and fees, and vacancy losses)

Initial Cash Investment is the total amount of cash you invest during the acquisition of the property. Initial Cash Investment includes the down payment, financing and closing costs, and any repairs, maintenance, or carry costs, that were accrued prior to renting the property.

NOI ÷ Initial Cash Investment = Cash-on-Cash Return

Example:

A property with a purchase price of $1,000,000 is purchased with an interest-only loan of $800,000 and closing costs of $20,000, at an interest rate of 10%, to be listed as a short-term rental for $135,000 a year through a management company that keeps 17% of the earnings per month, we can calculate as follows:

NOI – $135,000 rental income – $22,950 in management fees – $80,000 in mortgage payments = $32,050

Initial investment – $200,000 down payment + $20,000 closing costs = $220,000

NOI ÷ Initial Cash Investment = Cash-on-Cash Return

$32,050 ÷ $220,000 = 14.57% Cash-on-Cash Return

Being able to calculate your Cash-on-Cash quickly and effectively can give a strong insight into the effectiveness of your investment. If your property has a 10% cash-on-cash return, you will be earning back your initial investment in cash in only a decade. It is important to understand how quickly you will be cash-flowing while you are building equity, so you know the true pace of your returns.

What is the Difference Between Cash-on-Cash and ROI?

Return on investment, or ROI, is the measure of an investment’s profitability in a different form than cash-on-cash. The cash-on-cash return is a metric used to determine how quickly and effectively an investor can realize their initial investment; return-on-investment is the net profit divided by total costs. In the current market, the ROI will be minimal, as the expenses have scaled more quickly than the returns on real estate investment. An experienced investor will understand that ROI is a simple glance at the income ratio of a property, but that the current market will not show strong ROI. The current environment is for deft investors, looking to capitalize on opportunities that are harder to find and harder to obtain. Investors are only looking to cash flow enough to support their investments until the market settles and interest rates recede, and the number that truly matters to them is cash-on-cash, to measure their returns until they inevitably refinance.

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