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## How to Use Cash-on-Cash to Compare Investment Opportunities

In this real estate investment article, we want to discuss its meaning, advantages and disadvantages, popularity among real estate investors, and then explore the cash-on-cash formula with several examples of cash-on-cash returns.

So let’s begin.

The cash-on-cash return (or equity dividend rate) measures the ratio between the property’s estimated first-year cash flow before taxes (CFBT) and the amount of initial cash investment a real estate investor makes to purchase a rental property.

Here’s the idea: Cash on Cash is the percentage of cash flow on cash investments.

The popularity and use of cash-on-cash in real estate investing is because it provides investors with an easy way to compare the profitability of multiple investment opportunities. For example, an investor can compare the first-year yield of a real estate investment based on his cash-on-cash (or CoC) with the yield offered by a bank on a CD. In this case, for example, the investor may decide to invest his cash in an apartment complex that returns a COC of 7.6% rather than in a CD that pays 3%, and vice versa.

In general, however, cash-on-cash return is not considered a particularly powerful tool for measuring the profitability of an income asset because it does not consider the time value of money. In other words, because it does not compound or discount money over time, the CoC is restricted to measuring the cash flow of the investment property only in the first year of ownership.

However, cash-on-cash returns are not without validity. This will certainly provide real estate investors with a quick way to compare investment opportunities and similar income-producing properties.

How to calculate

Cash on Cash Return = Annual Cash Flow / Cash Investment

What does it mean?

Before we consider an example, let’s make sure we understand the components of a formula. It will be important to accurately calculate cash-on-cash in your own rental property analysis.

1) Annual Cash Flow – This is cash flow before tax (CFBT) as opposed to cash flow after tax (CFAT). In other words, it is the cash flow for the first year without adjusting for federal income taxes. CFBT is calculated by calculating annual rental income less annual operating expenses less annual debt service or loan payments.

2) Cash Investment – This is the total amount of initial cash required to purchase the property and includes the down payment, loan score, escrow and title fees, appraisal, and inspection costs.

Example

OK, let’s calculate the cash-on-cash return.

You are analyzing the profitability of a six-unit apartment building according to the following scenario. Each of the six units collects $1,000 per month. You estimate that first-year operating expenses will be $28,800. You need a mortgage of $126,000 down, a credit score of $2,940, and a monthly loan payment of $1,956. You estimate your closing costs, such as escrow, title, inspection, and appraisal fees, at $2,100.

First, calculate the annual cash flow:

Gross Scheduled Income $72,000 (6 units x $1,000 x 12)) Less Operating Expenses $28,800 equals $43,200 (Net Operating Income) Less Mortgage Payment $23,472 ($1,956 x 12) = Less $19,000 Cash

Next, calculate your cash investment:

Down payment of $126,000 plus loan points of $2,940 plus closing costs of $2,100 = $131,040 cash investment

Finally, calculate the CoC:

Cash on Cash Return = Annual Cash Flow / Cash Investment, or, $19,728 / $131,040 = 15.06%

Ok, now let’s implement it.

You are trying to decide where to invest $126,000 in cash. You can invest it in a 3% T-Bill at your local bank or, as you just discovered, you can buy a six-unit rental income property and get a cash-on-cash return of 15.06%. What do you do now? You may want to do a full-blown real estate analysis on the property and look at some other key returns and measures. Although on the surface, investment real estate seems like the most prudent real estate investment option, you cannot make a decision without more information and a more thorough real estate analysis.

But here’s a caveat. Be sure to use reliable property data for your analysis; Confirm that everything the seller or agent gives you is complete and accurate; Calculate all numbers and property data concisely and carefully.

With that said, here’s to your real estate investing success.

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