Cash on cash return, also known as the equity dividend rate,
is a property valuation formula that calculates the ratio of cash earned to cash invested (not including money borrowed to finance the purchase). In real estate, Cash-on-Cash return is the before tax cash flow (i.e. Cash Flow after Financing) of an investment in a given period divided by the equity invested (i.e. total equity capital invested) as of the end of that period. Cash-on-Cash return is a levered (after debt) metric, whereas the Free-and-Clear return is its unlevered equivalent. The metric used by real estate investors to assess potential real estate investments.
The cash-on-cash return is determined by taking the annual before-tax cash flow and dividing it by the total cash invested:
The following are two examples of how the cash-on-cash return is calculated:
If an investor recently invested $1,000,000 into a property and it provides an annual before tax cash flow of $100,000, then the cash-on-cash return would be:
If an investor recently invested $1,000,000 into a property and it provides an annual before tax cash flow of $200,000, then the cash-on-cash return would be:
Cash-on-cash return can become an effective prescreening tool for prospective commercial property owners that can provide a working idea of how beneficial investment in a property may be. It also provides you with fast and simple method to measure the long-term profitability of one or multiple investment properties. This allows an investor to easily choose the investment property with the highest potential return. Also, this metric can help an investor think ahead about the expenses associated with a potential investment property. It is also a great indicator of the effect of leverage as it is only looking at the net cash flow compared to the actual amount of cash invested.