Cash on Cash Return: A Comprehensive Guide

You are a buyer looking to invest in properties for rental income or to flip for profits, you may face challenges in measuring the profitability of your investments. This is where Cash on Cash Returns come in as a valuable metric. It allows you to assess how much return you earn on the cash you invested in a property. Like, in Dubai, you can effectively calculate the profitability of your investment and make informed decisions by calculating the cash-on-cash return. A good cash on cash return for Dubai ranges from 10% to 15%.

This article provides you with the following insightful cash-on-cash returns and how to calculate them using a simple formula. We also cover reasons why it is important and what is a good cash-on-cash return.

What is Cash-on-Cash Return?

Cash-on-Cash return is a key metric in real estate investing measuring the annual return on an investment relative to the cash invested. You can simply calculate by dividing the annual pre-tax cash flow by the total cash you invested. The formula you can use: (Annual Pre-Tax Cash Flow / Total Cash Invested) x 100% = Cash-on-Cash Return 

A higher cash-on-cash return signifies a more profitable investment providing more cash flow. As an investor, you can use this extra cash to cover the down payment for new properties. 

Think about it - the more returns you earn, the quicker you can grow your property portfolio. Below we'll show you how to boost your Cash-on-Cash returns and speed up your real estate investing journey.

Calculate Cash on Cash Returns

The cash-on-cash return formula is as follows: 

(Annual Pre-Tax Cash Flow / Total Cash Invested) x 100% = Cash-on-Cash Return

Calculating cash on cash return involves various expenses associated with your real estate investment. It is important to know these expenses as they directly impact your investment profitability. You will find some important variables and examples of expenses below that you should take into account when calculating cash on cash returns:

• Loan Costs
• Property Management Fees
• Maintenance and Repairs
• Property Taxes and Insurance
• Utilities
• Vacancy and Losses

Preparing expense lists is the most effective way to calculate your return because it helps you to accurately determine your monthly and annual cash flow. These numbers are essential requirements for effectively utilizing the equation. You will gain a clear understanding of the financial impact of your real estate investment by outlining your income and expenses. 

Cash on Cash Return Examples

Here's a step-by-step example of how to calculate the Cash on Cash Return (CoCR):

• Calculate Your Monthly Cash Flow: This is the monthly rental income you receive from your property minus your monthly expenses. For instance, you receive 5,000 AED monthly from your property income. You will subtract your monthly expenses to a total of AED 3,000 per month. The expenses may include mortgage, insurance, taxes, maintenance, etc.  So, AED 5,000 - AED 3,000 = AED 2,000. This AED 2,000 is your monthly cash flow.
  
  
• Convert to Annual Cash Flow: You can multiply your monthly cash flow by 12 to get your annual cash flow. In this case, AED 2,000 x 12 = AED 24,000.
  
  
• Add Up Your Initial Cash Investments: This is the total cash you invested in the property. It includes the down payment, closing costs, and any renovation costs. Let's say you invested AED 200,000 in total.
  
  
• Divide Your Annual Cash Flow by Your Initial Cash Investment: AED 24,000 / AED 200,000 = 0.12.
  
  
• Multiply the Resulting Fraction by 100%: This gives you your cash on cash Return as a percentage. In this case, 0.12 x 100% = 12%.
  
  
• Analyze Your Results: Your cash on cash return is 12% in this example. This means you earn 12% of your initial investment yearly from the rental income after expenses. This is a good return, but you should also consider other factors like property appreciation and tax benefits when evaluating your overall return on investment.

Why is Cash on Cash Important?

Cash on Cash Return is a vital metric as it offers a quick and clear snapshot of an investment property's profitability. This is particularly beneficial when you're planning to leverage property mortgages. For instance, a high cash on cash return indicates that your investment generates a healthy cash flow. Lenders often look at this cash flow when you apply for a new property loan or need to cover a down payment. 

Let's say you have a cash on cash return of 15% on your current property. This high return demonstrates to lenders that your investment is profitable and that you can manage and repay a new loan. Therefore, a good cash on cash return signifies a successful investment and paves the way for future investment opportunities.

What is a Good Cash on Cash Return?

A good cash on cash return varies depending on the country and the specific real estate market. Typically, investors consider a cash on cash return of 8% to 12% as favorable indicating a decent return on investment. It's crucial to remember that returns significantly differ based on economic conditions, risk factors, and property types within each country.

Let's compare a few examples to gain a better understanding. In the United States, investors commonly consider a Cash on Cash Return of 8% to 12% as good since the real estate market there is relatively stable. For instance, if you choose to invest in a residential rental property situated in a desirable location with high rental demand achieving a Cash on Cash Return within this range would be deemed favorable. On the contrary, in a dynamic and fast-growing market like Dubai, investors often expect higher returns due to the increased risk and potential for appreciation. However, it's important to conduct thorough market research and analysis as returns can vary depending on property location, type, market trends, and rental demand.

Using Cash on Cash for Down Payment

Utilizing cash on cash return is helpful for your down payment when considering your future rental property. Cash on Cash Return assists with the down payment by providing insight into the potential return on your initial cash investment and assessing whether the property's cash flow can support your down payment needs.

Cash on Cash Return helps you evaluate the property's profitability and determine if the generated income is sufficient to cover your mortgage payments and other expenses. Besides, you can estimate the percentage of return you'll generate from your initial cash investment by analyzing the cash on cash return. A higher cash on cash return indicates a stronger cash flow demonstrating that the property can generate more income than your investment.

Summary

Cash on Cash Return is an effective method for calculating the potential return on your rental properties. It allows you to assess the profitability of your investment by considering the income generated relative to your initial cash investment. You can make informed decisions about property investments and evaluate their ability to generate sufficient cash flow by analyzing the cash on cash return. This helps you maximize your returns and make the most out of your rental properties. Understanding and utilizing Cash on Cash Return can greatly contribute to your success.