“Is this property going to make money short and long term?”
It’s not always easy to determine if a property is an income-producing investment, and it certainly takes much more than just touring a property. This is why investors use a wide range of tools and formulas to compare the different properties.
One of these formulas that is critical to an investor’s success is cash on cash return, also known as the equity dividend rate.
In this article, we’ll explore what cash on cash return is and how you can use it to ensure that your next real estate deal will be profitable.
What is Cash on Cash Return, & Why is it Important?
Cash on cash return, or equity dividend rate, helps take the guessing work out of real estate investing.
Cash on cash return measures the income you could earn as a percentage of the cash you will invest in a property over a set period of time (generally one year).
It allows investors to analyze an investment’s cash flow without accounting for debt and, therefore, to determine the profitability of a property.
It’s also an excellent tool to utilize when comparing different rental properties in the buying process to determine which property will be more profitable.
Cash on Cash Return Formula
The cash on cash return formula divides the annual pre-tax cash flow of a property by the initial cash investment.
The cash on cash return formula is:
Cash on cash return = (Annual cash flow / Total cash invested)
Next, we’ll take a deeper look at each item in the formula.
Annual Cash Flow
To calculate the annual pre-tax cash flow, add the property’s gross rent to any additional earning opportunities, like parking fees. Then, subtract operating expenses, such as:
- trash collection
- HOA and bank fees
- property management
Total Cash Invested
The total cash invested generally includes:
- your down payment for the property
- your closing costs
- any pre-rental repairs and upgrades needed to make the property operational
- loan costs, though not including loan interest or payments
What is a Good Cash on Cash Return for a Rental Property?
Generally, a higher rate represents a higher cash on cash return and, therefore, a more profitable property.
However, what constitutes a good cash on cash return, or a good equity dividend rate, varies depending on the market and the investor’s goals.
As a rule of thumb, experts consider a property with a cash on cash return between 8% and 12% to be a worthwhile investment — and a cash on cash return in the double digits, such as 20%, is highly sought after.
Differentiating Cash on Cash vs. ROI
Return on Investment (ROI) is another formula that is frequently used to compare real estate investments that some investors use interchangeably with cash on cash return, though the two have differences.
The cash on cash return formula only considers returns relative to any money spent out of pocket by the investor.
Meanwhile, the ROI measures all returns for the property, including its debt, or loans.
The Bottom Line: Cash on Cash Return & Equity Dividend Rate
Though cash on cash return, or equity dividend rate, is a valuable tool in the toolbox for real estate investors, it’s not a one size fits all answer to the questions you may have about a property — or about real estate investing itself.
Keep in mind there are other tools, and other formulas, that need to be factored in, such as after repair value (ARV).
The difference between a profitable deal and a deal that loses money is education, which is why it's critical to utilize additional resources to further your real estate education.