Are you talking to your family and friends about purchasing a rental property? Before letting some bad stories about investing in rental properties scare you, do the math!
Buying a rental property should never have to be a bad decision. Instead, look to the numbers and financial calculations to protect you and your investment.
One of the most important facets of rental property investment that you have to calculate is the cash on cash return. Do not worry if you are not a numbers person; you can simply use the online cash on cash return calculator to do it for you!
So, what is cash on cash return and what can it do for your investment?
What Is Cash on Cash Return?
Cash on cash return is a ratio (usually in percentage) that considers the total cash you earn against your total investment. Here, the total cash earned is the annual pre-tax cash flow amount.
This cash on cash return rental property metric allows a simple assessment of cash flows from your income-generating asset. The ratio is a critical component in commercial real estate transactions. Some people call it the equity dividend rate.
It’s important to remember that property investments involve a significant amount of debt. This means that carrying out a return on investment (ROI) calculation loses relevance when you consider debt as money invested.
However, cash on cash return rental property calculator excludes all debts and tests the actual cash you invest.
Example of Cash on Cash Return
Suppose you buy a rental property for $1 million. You make a down payment of $200,000 and take on a bank mortgage of $800,000. Besides the down payment, you also put in some $20,000 for transaction fees. And, let’s say you get tenants right away.
After a year, your rental income should be approximately $120,000. Mortgage costs, plus the principal payment and interest, come to $30,000.
First, you should determine the annual cash flow from your investment in the first year. Yearly cash flow = annual rent less mortgage payments, so it will be $120,000 less $30,000, which is $90,000.
Then, find out the total cash you have put into your investment. Total cash investment = down payment plus fees, so it will be $200,000 plus $20,000, which is $220,000.
Finally, use the information above to determine cash on cash return in your first year. Cash on cash return = $90,000 divided by $220,000, which is 0.41 or 41%.
How to Calculate Cash on Cash Return
Tax is not a factor in calculating cash on cash return because the rental property return is the same, regardless of who runs the business. However, the amount of income tax you pay differs from one investor to another. Using pre-tax cash flow in the calculation makes it easy to make comparisons between different real estate investments and investors.
Cash on cash return differs from cash flow in two ways:
- Cash on cash is a percentage or ratio, while cash flow outcome is an amount.
- Cash flow shows how much money you have in your bank after paying all expenses, not including income tax. Cash on cash, on the other hand, tells you the return you are receiving for the investment amount you have put into a property.
What Makes a Good Cash on Cash Return?
There is no exact ratio or number that provides you with a definitive answer to excellent cash on cash return calculator result.
Some investors are happy with investments that offer between 8 to 12 percent cash on cash return, while others argue that a 5 to 7 percent rate is an acceptable offer.
If you are just starting out in rental property investment, low cash on cash return is suitable. You can raise your standards as you gain experience and have more understanding of what you want in a rental property.
Another factor to consider when using a simple cash on cash return calculator is your investment objectives. For instance, properties in a growing environment are likely to have low cash on cash return rate, but that does not make them poor investments.
A cash on cash calculator lets you measure returns as an important part of cash flow in accounting. The calculator also helps determine the viability of a potential deal and how much you should put toward the down payment. The next time you find a potential rental property investment, try implementing the cash on cash return formula and find out how versatile it can be.
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