| The Cash-on-Cash Return is a measure of an income | | | | operations in their pro forma. However, the projections |
| producing property's interest rate return on invested | | | | for the following years are all subject to the buyer's |
| equity. The ratio is derived by taking the annual net | | | | assumptions. Those assumptions can prove wildly |
| cash flow (i.e., the cash flow available to the investors) | | | | incorrect. |
| divided by the equity invested. | | | | Shortcoming #2: Cash-on-cash can be manipulated by |
| Cash-on-Cash Return = Net Cash Flow / Invested | | | | the property's performance both good and bad. A |
| Equity | | | | property that is forecast to operate at 93% |
| There are four types of cash-on-cash return: | | | | occupancy but is operating at 95% occupancy may |
| Leveraged, Unleveraged, Before Tax and After Tax. | | | | produce a higher cash-on-cash return for the investor. |
| Consider the following examples: | | | | Alternatively, the same property could be at 92% |
| Example 1: Suppose an investor purchases a property | | | | occupancy and the owner may choose to defer |
| for $10,000,000 with an equity investment of 25% - | | | | certain maintenance items to maintain his cash on |
| $2,500,000. At the end of the first year, the available | | | | cash. In this scenario, the cash-on-cash return may be |
| cash to be distributed to the investor is $200,000. The | | | | what was projected but it comes at a future cost as |
| leveraged, before tax cash-on-cash return would be: | | | | deferred maintenance will need to be performed |
| $200,000 / $2,500,00 = 0.08% x 100 = 8.00% | | | | sometime. |
| Example 2: Let's assume the investor has a federal | | | | Shortcoming #3: Returns are increased by interest |
| and state tax rate of 25%. Then, the leveraged, after | | | | only mortgages. Since a principal payment does not |
| tax cash-on-cash return would be: | | | | need to be made there is more cash flow available to |
| $200,000 x 25% = $50,000 | | | | the investor. This will provide higher cash payments but |
| $200,000 - $50,000 = $150,000 | | | | will reduce the sale proceeds at the end as a greater |
| $150,000 / $2,500,000 = 0.06% x 100 = 6.00% | | | | amount of principal will need to be prepaid |
| Example 3: Alternatively, the investor purchased a | | | | Shortcoming #4: It does not take into account property |
| property with all-cash for $10,000,000. Since there are | | | | appreciation. Some investors may opt for lower |
| no loan obligations, the investor is entitled to all of the | | | | cash-on-cash returns to invest in a property that has a |
| net cash flow available. Assuming the property has a | | | | greater chance of appreciation than purchasing a |
| net cash flow of $740,000 then the unleveraged, | | | | property with stabilized cash-on-cash returns but little |
| before tax cash-on-cash return would be: | | | | to no appreciation. |
| $740,000 / $10,000,000 = 0.074% x 100 = 7.40% | | | | Shortcoming #5: The less equity into the property, the |
| Example 4: Again, let's assume the investor has a | | | | higher the cash-on-cash returns. It stands to reason |
| federal and state tax rate of 25%. Then, the | | | | that the less equity used to purchase an asset the |
| unleveraged, after tax cash-on-cash return would be: | | | | greater the returns to the investor. Some may argue |
| $740,000 x 25% = $185,000 | | | | this is not a shortcoming. However, consider that by |
| $740,000 - $185,000 = $555,000 | | | | putting less equity into a property up front it increases |
| $555,000 / $10,000,000 = 0.0555% x 100 = 5.55% | | | | the risk to the investor when it comes time to |
| Similar to a cap rate, the cash-on-cash return is a | | | | refinance or sell especially if the property has had little |
| simple metric an investor can use to evaluate the | | | | appreciation or has experience depreciation. If you are |
| potential return of a property (i.e. "risk") versus an | | | | tempted to do this make sure that the reward is well |
| alternate investment such as a US Treasury Bond. It is | | | | worth the risk. |
| a reliable tool for stabilized properties but does have | | | | It should be noted that most cash-on-cash returns are |
| several short comings an investor should consider. | | | | quoted before tax. The main reason is that each |
| Shortcoming #1: Cash-on-cash is most reliable in the | | | | investor's tax situation is unique. An investor should use |
| first year than in the future years. This is due to the | | | | cash-on-cash return as just one of several metrics in |
| immediacy of the income. Most property buyers try | | | | evaluating a specific property for purchase. |
| hard to accurately reflect a property's first year of | | | | |