Using Cash-on-Cash (CoC) to Measure Income Property Profitability
Cash-on-cash return (CoC) measures the ratio between a rental income property’s anticipated first-year cash flow to the amount of cash real estate investors invest to purchase the real estate investment property.
Popular But Not Particularly Powerful
Real estate investors typically use the cash on cash return in two instances: To gauge the profitability of real estate investments against other investment opportunities, and to compare the profitability of similar real estate income-producing properties. To discover the return an investor might receive investing in T-bill compared to investing in real estate, for instance, or purchasing an apartment complex compared to a commercial real estate office complex.
Cash on cash is a popular measurement of income property profitability mostly because cash-on-cash is an easy return to compute. Moreover, for this reason, because cash-on-cash return is popular amongst real estate analysts, many real estate investment software programs include the cash-on-cash return in their software solutions.
Despite its popularity, however, cash on cash (CoC) is not a particularly powerful tool for measuring the profitability of rental income property. This is mostly due to the fact that cash on cash doesn’t take into account time value of money, and as a result must be restricted to measuring a property’s first year (not its future year’s) cash flow.
Calculating Cash-on-Cash (CoC)
The cash on cash computation has two parts: Cash invested and the rental property’s annual cash flow.
In this case, “cash invested” meaning the total amount of cash the investor expects to initially invest to purchase the property such as down payment, loan points, escrow and title fees, appraisal, and inspection costs, and “annual cash flow” being the cash flow before tax (CFBT) generated by the investment property in the first year of operation. Here’s the formula:
Annual Cash Flow / Cash Invested = Cash on Cash Return
Don’t Make Investment Decisions Based Solely on Cash on Cash
Real estate investment decisions should never be made solely on cash on cash return; there are better ways to evaluate income-property investments.
Nonetheless, cash on cash return is not without validity. So it helps to be aware of it, to know how to calculate it, and perfectly fine to include it in your cash flow analysis reports.
