Cash on Cash Return
Multifamily income property is a great source of passive income, but how much you make depends on several factors and applicable taxes. If you have decided to invest your hard-earned money in a multifamily apartment property, it is good to understand operating fundamentals and how to measure your investment. There are a number of key performance metrics (KPI) you can consider you.
One important metric to calculate for your income property is cash on cash return. It is used to evaluate the profitability of an investment property. This blog will cover the major points of cash on cash return.
What is Cash on Cash Return?
It is a popular metric used by property investors to evaluate return on investment (ROI). It is an investor’s annual return on their equity invested in an investment property.
How do You Calculate Cash on Cash Return?
You can calculate cash on cash return by taking your investment property’s annual after-debt but before-tax cash flow and dividing it by your total cash invested. The concept is simple but coming up with the annual after-debt but before-tax cash flow is a detailed and in many ways subjective process
Cash on Cash Return = ADBTCF/Equity
Suppose your investment property generates a cash flow of $10,000 for the year and your total equity investment is $100,000; your cash-on-cash return is 10%.
How do You Determine After Debt Service But Before Tax Cash Flow?
Annual before-tax cash flow =
Gross Collected Rent + All Other Income – Operating Expenses – Mortgage Interest Payments
All of this information can be found in your multifamily investment property’s annual financial report. It is basic math with the only key thing of note being, you do not include any principal paydown in your mortgage payment but rather just the interest portion.
How do You Determine Your Total Equity Invested?
You add up all of the equity that has been invested in the property to this point. It includes the initial downpayment and any other equity investments that have been necessary since the purchase.
Why is it Important for Investors to Understand Cash on Cash Return?
When making a property investment, an investor needs to learn about several key performance metrics (KPI). It allows them to make sound decisions and understand how their investment is doing. Cash on Cash return is a commonly used metric in multifamily investment real estate.
It helps you determine if the investment property is generating an adequate return on investment. If it is not, it allows the property investor to assess where it is not meeting the grade.
If the property investor has multiple income properties, he can compare one versus the other to determine which ones are doing the best and why. This can have a positive effect on future investment strategy and identify how to better the performance of their existing multifamily investments.
What Factors Can Affect Cash on Cash Return?
- Rental Growth Rate
- Vacancy/Occupancy Rate
- Rising Variable Operating Expenses
- Repairs and Maintenance
- Fixed Operating Expenses
- a. Property Taxes
- b. Insurance
- c. Utilities
- Capital Expense
- Mortgage Interest Expense
What is a Good Cash on Cash Return?
It varies from market to market. A good CCR in Seattle may not be the same as one in Atlanta.
As a general rule property investors believe a CCR of 8 to 12 percent is worthwhile depending on the multifamily property location and its asset class. The general theory is the worse the asset class or location the higher the expected cash on cash return.
Cash on Cash Return: Conclusion
Understanding your multifamily investment and how to maximize return is critical to your success. Cash on cash return is a common valuable metric. This number is useful when communicating investment status with partners. It is something everyone easily understands.
A well-maintained investment property can go a long way to maximizing cash on cash return. It can impact maximizing income, efficient expenditure, etc. Summerfield Property Management is an experienced team of management professionals that can help you maximize the return on your apartment investment. If you own apartment properties that are 75 units or greater we would love to talk!
Cash on Cash Return: FAQs
Q: What is the difference between Cash-on-Cash Return and Return on Investment?
A: ROI calculates the total return, including debt, whereas CCR measures the return on actual cash invested.
Q: Are Cash-on-Cash return and cap rates identical?
A: If you don’t have a debt service on the property, then cash-on-cash return and cap rates can be identical. However, most investors use the power of leverage, so these metrics generally differ.
Q: Why do we consider the annual before-tax cash flow for CCR calculation?
A: Investor tax rates differ based on their income, which is unpredictable when analyzing potential properties. By excluding tax from the calculation, it allows one to have a better sense of individual investment performance.