Cash on Cash return is a metric used to evaluate the potential cash flow and profit of a real estate deal. It is the percentage rate that measures the cash flow received relative to the amount of money invested to acquire the asset. I use this metric as one of the main factors when deciding if a property is worth pursuing or not.
It is quite simple to calculate. You simply take your monthly rental income and multiply that by 12 to get your yearly income. After that you take out operating and maintenance expenses to leave you with your yearly cash flow. That is then divided by the amount of money you spent to acquire the asset, such as down payment, closing costs, and repair costs. Multiply this by 100 to get your cash on cash return percentage.
When evaluating deals I look to get at least a 12% cash on cash return. Where do I get that number from? Historically, the average return you can get long term from the stock market is around 7%. This involves basically no work except for finding a mutual or index fund to park the money in and forget about it. Using that as a baseline, I want to achieve at least 5% higher to justify the work required to manage and maintain a rental property. Getting a 12% return is completely achievable in the Beaver and Allegheny county real estate markets.
I think cash on cash return is a great metric to use to evaluate a potential deal because it is quick and easy allowing you to figure out the potential return of an investment in no time at all. It is a good evaluation to do at the beginning stages of analyzing a property’s potential profit. Granted, this is not the only number I rely on to determine whether a property is worth pursuing or not, but it is very helpful to help determine a good offer price.
A trick I like to use to achieve a better cash on cash return is to ask for a seller assist with any property that I purchase. What this means is I ask the seller to pay for a portion of my closing costs, thus decreasing the amount of money I have in the deal. This also increases my cash on cash return! This assist just comes out of their take home money at closing so a $100,000 offer with a 6% seller assist is the same as a $94,000 offer with no assist for them. I would much rather pay the extra $6,000 over a 30 year mortgage that the tenants will be paying down, rather than pay for it up front out of my pocket. Owner occupied properties allow you to ask for as much as 6% seller assist, while investment properties usually allow up to 2%.
The great thing about real estate is you can achieve a better cash on cash return than you would in the stock market but that is not the only profit source from the investment! This metric does not even include potential appreciation, loan pay down, and tax benefits. That increases your actual return to sky high levels! I don’t account for these in the cash on cash analysis however, and just view them as icing on the cake.