Understanding Cash-on-Cash Return
Cash-on-cash return is one of the simplest measures in income-producing real estate, which is exactly why it is so often misused. It answers a narrow question well and a broad question badly.
The calculation
Cash-on-cash return divides the annual pre-tax cash flow after debt service by the total cash actually invested. Cash invested includes the down payment, closing costs, and any capital put in at acquisition to make the property operational.
If a property produces annual cash flow after debt service of a given amount, and the buyer invested a certain amount of cash to acquire it, the ratio of the two is the cash-on-cash return for that year.
What it measures well
It measures the current yield on the money actually at risk, under the financing actually used. That makes it useful for comparing what different opportunities do for an investor's cash position in the near term.
What it does not measure
It ignores principal paydown, appreciation, tax treatment, and any change in performance over time. It is a snapshot of one year, not a measure of total return.
It is also highly sensitive to leverage. More debt can raise cash-on-cash return while simultaneously increasing risk, which is why the figure should never be read without also reviewing debt coverage.
- Cap rate: unlevered, describes the asset independent of financing
- Cash-on-cash: levered, describes the current yield on invested cash
- Debt coverage ratio: describes the cushion between income and debt payments
- Total return: includes amortization, appreciation, and tax effects over the hold
Use it alongside other measures
A reasonable review looks at cap rate to understand the asset, cash-on-cash to understand the near-term yield, debt coverage to understand the risk, and a multi-year projection to understand whether the first-year figure is representative or temporary.
A high first-year cash-on-cash return produced by an unusually low expense year, deferred maintenance, or short-term interest-only debt is not a durable result.
The takeaway
Cash-on-cash return is a useful current-yield measure, not a verdict. Read it next to cap rate, debt coverage, and a multi-year view before drawing conclusions.
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This article is part of a broader set of subject pages covering business development, business acquisitions, and real estate investing. You can also read more about Simon Leizgold.
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