What is Cash-On-Cash Return
Cash-on-cash return is a rate of return often used in real estate transactions that calculates the cash income earned on the cash invested in a property. For example, when an investor purchases a rental property, she might put down only 10% for a cash down payment. Cash-on-cash return measures the annual return the investor made on the property in relation to the down payment only.
Cash-On-Cash Return – Summarized
Cash-on-cash return is a metric normally used to measure commercial real estate investment performance. It is sometimes referred to as the cash yield on a property investment. The cash-on-cash return rate provides business owners and investors with an analysis into the business plan for a property and the potential cash distributions over the life of the investment.
Cash-on-cash return analysis is normally used for investment properties that involve long-term debt borrowing. When debt is included in a real estate transaction, as is the case with most commercial properties, the actual cash return of the investment differs from the standard return on investment (ROI).
Calculations based on standard ROI take into account the total return of an investment. Cash-on-cash return, on the other hand, only measures the return on the actual cash invested, providing a more accurate analysis of the investment’s performance.
Calculating the Cash-On-Cash Return
Cash-on-cash return only uses an investment property’s pre-tax inflows received by the investor and the pre-tax outflows paid by the investor. For example, suppose a commercial real estate investor invests in a piece of property that does not produce monthly income. The total purchase price of the property is $1 million, and the investor puts $100,000 down and borrows $900,000. There are closing fees, insurance and maintenance costs of $10,000 the investor also pays out of pocket.
After one year, the investor has paid $25,000 in loan payments, of which $5,000 is principal repayment and the rest is interest. The investor then decides to sell the property for $1.1 million on the one-year date. This means the investor’s total cash outflow is $135,000, and after the debt of $895,000 is repaid, he is left with a cash inflow of $205,000. The investor’s cash-on-cash return is then: ($205,000 – $135,000) / $135,000 = 51.9%.
In addition to deriving the current return, the cash-on-cash return can also be used to forecast the expected future cash distributions of an investment. However, unlike a monthly coupon payment distribution, it is not a promised return but is instead a target used to assess a potential investment. In this way, the cash-on-cash return is an estimate of what an investor may receive over the life of the investment.
Cash-On-Cash Yield
Cash-on-cash yield is a basic calculation to estimate the return from an asset that generates income. Cash-on-cash yield also refers to the total amount of distributions paid annually by an income trust as a percentage of its current price. The cash-on-cash yield is a measurement technique that can be used to compare different unit trusts.
Cash-On-Cash Yield – Summarized
The cash-on-cash yield is useful as an initial estimate of the return from an investment, but has a number of limitations. It may overstate yield if part of the distribution consists of a “return of capital,” rather than a “return on capital,” as is often the case with income trusts. Also, as a pre-tax measure of return, it does not take taxes into consideration. For example, if an apartment priced at $200,000 generates monthly rental income of $1,000, the cash-on-cash yield on an annualized basis would be 6%.
In the context of income trusts, assume a trust with a current market price of $20 pays out $2 in annual distributions, consisting of $1.50 in income and 50 cents in return of capital. The cash-on-cash yield in this case is 10%, but since part of the distribution consists of return of capital, the true yield is 7.5%. The cash-on-cash yield measure overstates the return in this case.
Return
A return is the gain or loss of a security in a particular period. The return consists of the income and the capital gains relative on an investment, and it is usually quoted as a percentage. The general rule is that the more risk you take, the greater the potential for higher returns and losses. Return is also used as an abbreviation for income tax return.
Return – Summarized
While some investors will settle for principal protection, most investors are in search of return, specifically alpha returns. Alpha returns are generated when an investment generates more money than it costs. In general, there are three different types of return measures: return on investment, return on equity and return on assets. Each one is essentially calculated the same way, but the inputs have different labels.
Return on Investment
The most common return measure, also referred to as the return on investment, or ROI, is calculated by dividing the cost of the investment by the difference between the cost of the investment and the gain on the investment. It is the most generic way to calculate return and is the basic formula used to calculate other return measures. For example, if an investor pays $100,000 for real estate and then sells it for $110,000, the return is calculated by taking the difference between $100,000 and $110,000, and then dividing that number by the cost of the investment, or $100,000. The calculation is $10,000 divided by $100,000, or 10%.
Return on Equity
Return on equity, or ROE, is another commonly used measure of return used by those analyzing business performance. In this case, a company’s net income is the gain or loss, and the cost is the average of the company’s equity. ROE is used by investors looking for a return on the company’s equity capital. If a company makes $10,000 in net income for the year, and the average equity capital of the company over the same time period is $100,000, the return on equity is 10%.
Return on Assets
Yet another commonly used measure of return is the return on assets, or ROA. It is commonly used as a measure of return by those analyzing financial stocks. In this case, net income is also the gain, but the investment is the assets of the company. Net income divided by average total assets equals ROA. For example, if net income for the year is $10,000, and total average assets for the company over the same time period is equal to $100,000, the return on assets is $10,000 divided by $100,000, or 10%.