You may not be familiar with Cash on Cash return simply because you are not living in the real estate world. To start with it, cash on cash return formula is as follows:
Cash return is equivalent to the net operating income over total cash investment
The total cash investment/s consists of all expenses that can let the rental property equipped and operational. The net operating income on the other hand is the monthly rental the landlord receives from the rental property.
The calculation is different from a rental property purchased in cash and loan. To further explain, check out calculation below:
Table of Contents
No Loan
Fortunately for others, they can pay a rental property in cash, and to this, they are given the opportunity to make more money from the property. To calculate CoC for rental property acquired in full, follow the calculation below:
Rental property cost: $300,000
Expenses: $500 (for rental property operational expense)
Rent a month: $2000
Monthly income: $2000 – $500 = $1500
Annual income: 12months X $1500 = $18,000
Con Cash Return: $18000 / $300,000 = 6%
With Loan
Sure, not everyone can pay $300,000 or even lesser, immediately, hence acquiring a loan to get a rental property is considered. Needless to say, it is a good investment, hence getting a loan is not a bad idea at all. To calculate for CoC with rental property acquired using a loan, follow calculation below:
Rental property cost: $300,000
Expenses: $500 (for rental property operational expense) + $500 (debt service) (the amount varies on the mortgage rates) = $1000
Rent a month: $2000
Monthly income: $2000 – $1000 = $1000
Annual Income: 12months X $1000 = $12,000
Cash on Cash Return: $12,000 / $300,000 = 4%
In the calculation provided above, you can see that there is an obvious difference on the CoC return percentage between the no loan to with loan. Needless to say, the calculation will be the same once the loan is completely paid.
How To Determine If The Cash On Cash Return Is Good Or Not?
There are some who claim that anything exceeding the 8% mark is good, hence they will aim for rates between 8% to 12%. But other investors are not completely happy with it, they will not consider rental property as good investment, if it cannot give them a rate of beyond 20%.
But this you have to keep in mind, the CoC return differs from
- The location
- The type of property
- Rental strategy
Since, CoC is pretty straightforward and uses simple metric, Cash on Cash return does not say all you need to know about rental property, like tax benefits or value appreciation are not factored or considered. Hence, this formula is only recommended to use when you are considering a property to buy.
There are more complicated and sophisticated formula and metrics to use that can provide you more in depth information, yet needless to say, using CoC is a good formula to start with.