Cash on cash return is a rate of return ratio that calculates the total cash earned on the total cash invested. The amount of the total cash earned is generally based on the annual pre-tax cash flow.
Cash on cash return is a simple financial metric that allows the assessment of cash flows from a company’s income-generating assets. The ratio is primarily used in commercial real estate transactions. In the real estate industry, the cash on cash return is sometimes referred to as the cash yield on a property investment.
The financial metric is particularly significant in the commercial real estate industry because of the nature of the transactions in the industry. In most cases, investments in properties are carried out using a large amount of debt. Therefore, the return on investment (ROI) calculation loses its relevance because it accounts for all the money invested, including debt.
In contrast, cash on cash return excludes debt and evaluates only the actual cash amount invested. In such a scenario, an investor can obtain a more precise performance of his investment.
The cash on cash return is calculated in the following way:
However, because pre-tax cash flow is used in the calculation, an investor should always be aware of the tax treatment of his investment. If the cash on cash return is low, high taxes may erase any potential investment returns.
Suppose ABC Development decides to purchase a commercial space for $1 million. The company pays $200,000 in down payment and takes a mortgage of $800,000 from a bank. Besides the down payment, the company is required to pay $20,000 in various fees. ABC Development is going to lease the commercial space to various businesses.
After one year, the annual rental revenue from the property is $120,000. In addition, mortgage payments, including the principal repayment and the interest payments, are $30,000.
First, to calculate the cash on cash return, we need to determine the annual cash flow from the investment. The annual cash flow of ABC Development in the first year is: