Cash-on-cash return is a metric used to determine the rate of return on the cash invested in a commercial real estate or investment property. Since most real estate investors use leverage to buy properties, cash-on-cash return can provide a better idea of the value the investment produces for the cash put into the investment. It differs from cap rate and return on investment by focusing exclusively on cash flows.

## What is cash-on-cash return?

Cash-on-cash return is calculated by taking the annual pre-tax cash flow from a property and dividing it by the amount of cash invested. Cash invested includes the down payment, as well as any additional out-of-pocket fees paid to close the deal.

Cash-on-cash return is typically calculated for a one-year period, fluctuating from year to year. Investors can use a target cash-on-cash return estimate to plan the amount of cash to invest in a property and to provide an estimate for cash distributions from the investment each year.

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## How to calculate cash-on-cash return

Calculating cash-on-cash return is relatively straightforward.

Cash-on-Cash Return = Annual Pre-Tax Cash Flow ÷ Invested Equity

Pre-tax cash flow is calculated by adding rents, other operating income, and gains on the sale of a property, then subtracting operating expenses like maintenance or paying a property manager, as well as property taxes and mortgage payments.

Invested equity is simply the amount of cash the investor brought to closing.

It's worth pointing out that cash-on-cash return only looks at invested equity, so it's a leveraged metric. That differs from a metric like capitalization rate (cap rate), which uses the property's entire value to calculate returns.

## What's a good cash-on-cash return?

A good cash-on-cash return depends on the person investing and the types of properties they're investing in.

A good rule of thumb, however, is to look for a cash-on-cash return of at least 8% from a prospective investment. Anything lower, and you might be better off putting your cash to work in a different investment.

Consider that the S&P 500 has historically returned almost 10% annually for the last 95 years if you reinvested dividends. Although real estate may provide a nice diversifying asset for a portfolio, a simple index fund investment could provide significantly more upside than a subpar real estate investment. Plus, it has the added advantage of being extremely easy to manage compared to commercial property or other real estate holdings.

## Cash-on-cash return vs. cap rate vs. return on investment

Cash-on-cash return isn't the only metric real estate investors use to assess a potential addition to their portfolio. Many investors will also look at the capitalization rate and the expected return on investment.

• Capitalization rate, or cap rate, is the annual net operating income as a percentage of the value of the property. It removes debt entirely from the equation, so there's no cost of servicing a loan factored into the cap rate. It also removes the impact of using leverage. The cap rate is equal to the cash-on-cash return if no debt is used to purchase a property.
• Return on investment (ROI) is similar to the cash-on-cash return but includes the value of the debt used to buy the property. So, the costs of servicing a loan are deducted from operating income along with other operating expenses to determine ROI. Again, if no debt is used to purchase a property, the ROI will equal the cash-on-cash return.

Cash-on-cash return is one of the most important metrics for real estate investors, but it's not the only thing that matters. A property should also produce a cap rate that meets the investor's criteria to ensure they're not over-leveraging just to produce a higher cash-on-cash return. A poor cap rate or ROI could indicate that the property isn't a great investment.

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