How to Figure Out Your Cash-On-Cash Return
Cash flow is one of the most essential reasons to invest in rental homes. A method known as the cash-on-cash return is one of the easiest ways to measure cash flow (CoC for short).
What is Cash-on-Cash Return?
The cash-on-cash return is a metric that gauge's cash flow.
After you collect rent and pay all of your rental property bills, you have cash flow (including your mortgage but not including income taxes). Net Income After Financing is a more specific term for this cash flow (NIAF).
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The cash-on-cash return tells you how much NIAF is worth in comparison to your initial cash investment. In other words, it indicates how much of your initial cash investment you will receive back in a year.
Here is how the Cash-on-Cash Return formula looks like.
Cash-on-Cash Return
= Net Income After Financing (NIAF) ÷ Total Cash Investment
What Does a Good Cash-On-Cash Return Look Like?
For those wondering what makes a good return rate, there is no set rule of thumb. Investors appear to agree that a projected cash on cash return of 8 to 12 percent is indicative of a worthwhile investment. Others, on the other hand, maintain that in specific markets, even 5 to 7% is appropriate. A novice investor may begin with a lower cash-on-cash return requirement and gradually raise their expectations as they gain experience and a better understanding of what to look for in a rental property.
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For an example:
Calculate the amount of pretax cash flow first to determine the CoC return (rent minus debt service). Then divide it by the amount of money you put in at the start (down payment). If you make $12,400 in rent and pay $6200 in expenses, your cash flow is $6,200 Your CoC return would be $6,200/$60k = 10% percent if your down payment was $60k.
The cash-on-cash return formula not only allows you to calculate returns as a function of cash flow, but it may also assist you in determining whether a possible purchase is viable or how much to put down on a home. Be careful, CoC isn’t the only formula you use. The most successful investors examine offers using a combination of measures rather than just one.
Other formulas to consider when purchasing an investment.
The 50% Rule
According to the 50% rule, real estate investors should expect a property’s operating expenses to be around half of its gross income. This excludes any mortgage payments (if any), but does include property taxes, insurance, vacancy losses, repairs, upkeep, and owner-paid utilities.
The 70% Rule
According to the70% rule, an investor should spend no more than 70% of a property’s after-repair value, or ARV. This includes both the purchase price of the property and any expected repair costs.
The 1% Rule
In real estate investing, the 1% rule compares the price of an investment property to the gross revenue it will earn. The 1% rule states that a potential investment’s monthly rent must be equal to or less than 1% of the purchase price.
The 2% Rule
The 2% rule in real estate, like the 1 percent rule, can assist investors in determining the rent-to-price ratio. This rule of thumb is based on the same concept as the 1% rule. The 2% rule, on the other hand, recommends that a rental property is a smart investment if the monthly rent is equal to or greater than 2% of the purchase price.
At the closing table…
Cash on cash return is a very useful indicator when undertaking investment property research because of its simplicity and convenience of usage. The CoC return can be used by real estate investors to find potentially profitable purchases. Finding a good cash on cash return on an investment property might mean thousands of dollars in future income.
While the cash-on-cash return has flaws, it’s an excellent metric to value investment properties. When combined with these other metrics, it will provide you plenty of information to make an offer on an investment property. And that’s exactly what we’re here for: to help you expand your portfolio.
