Cash on Cash Return

What is Cash on Cash Return (COCR)?

Cash on Cash Return is a type of metric that is used in measuring the total return earned on real investment property, the return is the total cash income earned on the investment property to put in simple words,  Cash on cash return is earned by the investor made on by investing in the property than by mortgaging it and is calculated as the ratio of the total amount of rental income generated from property and total cash investment initially made in the property.

Formula

Cash on cash return formula

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For eg:
Source: Cash on Cash Return (wallstreetmojo.com)

This formula is to be noted that the equity dividend rate only measures the return on actual cash invested, i.e., the equity involved in the investment. Thus, the measure does not include the debt involved in the purchase of the property, which is a common financing instrument in real estate.

How to Calculate Cash on Cash Return (with Example)

Let us consider the example by using the above COCR formula:

Investment Without Loan

An investor purchases a property for $ 2,000,000 and receives a monthly rent of $ 8,000. He has to pay maintenance charges of the property of $ 2,000.

  • Now, the monthly income on the property = 8000 – 2000 = $ 6,000
  • Annual Income = 12 X 6000 = $ 72000
  • Thus, COCR Formula = Annual before tax cash flow/Total cash Invested = 72000/2000000 = 3.6%

Investment in the Property with Loan

An investor purchases a rental property of $ 2,000,000 with a down paymentDown PaymentDown payment is the initial deposit made by the buyer to the seller when purchasing an expensive item, such as residential property or a car. It comprises a portion of the total purchase amount of the asset and takes place via cash, bank check, credit card, or online banking. read more of $ 500,000. He receives monthly rent of $ 8,000 and pays maintenance and interest charges of $ 4,000 every month.

  • Now, the monthly income after expenses of the investor = 8000 – 4000 = $ 4,000
  • Annual income = 12 X 4000 = $ 48000
  • Thus, Cash on Cash Return = 48000/500000 = 9.6%

In the examples above, the loan increased this ratio. Loans or leverage increases the risk for the investor. Any damage, extra costs, impairment losses, loss of capitalLosses, Loss Of CapitalCapital Loss is a loss when the value of the consideration received from the result of the transfer of capital assets is less than the aggregate value of the cost of acquisition & cost of the improvement. In simpler words, it can be stated as the loss derived from the transfer of capital assets.read more have to born by the investor himself, and the banks need to pay back on time.

However, it is not always the case; this ratio depends on a lot of other factors like the price, the loan amount, monthly rent, monthly loan payouts, etc.

Cash on Cash Return and Return on Investment (ROI) Differences

Differences between COCR and Return on Investment (ROI):

Return on investment involves the total return on investment. It would consider capital gains on the investment as well. Whereas this accounts for only the annual cash inflows. Since the COCR in real estate investing, the assets are held for a very long term, usually 10-20 years, capital gains are difficult to estimate. Further, capital gains on the property depending on the location of the property, geopolitical scenario, economic conditions, and other factors.

Thus, to measure and compare the investment in real estate investing, COCR is a better measure.

Advantages

Disadvantages

What is a Good Cash on Cash Return Ratio?

The absolute number for a good COCR varies. While the experts say that an 8% return is a good ratio whereas some experts look for a range between 8-12%. Some investors may not invest if they are not guaranteed 15% or 20% COCR.

Conclusion

The equity dividend rate gives the ratio of before-tax cash inflow by the amount of equity initially invested. It does not include the loans taken from the financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more while calculating cash on cash return ratio.

Although this is a simple metric, it does not tell everything about the rental property and should not be taken as the only measure to make an investment decision. COCR in real estate investing requires a deep and sophisticated level of analysis, which includes qualitative analysis like the location of the property, future prospects of the area, commercial aesthetics of the location, among other factors.

A good COCR ratio does not consider the tax benefits, alternative financing sources, possible financing structure. However, a good COCR ratio remains the most basic and important metric to indicate a better investment opportunity.

This article has been a guide to what is Cash on Cash Return. Here we discuss how to calculate Cash on Cash Return in real estate using its formula along with practical examples, uses, advantages, and disadvantages. You can learn more about financial analysis from the following articles –

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