July 6, 2023
Adam Hoeksema
If you're an investor who's venturing into the world of real estate, or even a seasoned professional looking for a refresher, this guide is your key to understanding one of the most crucial metrics in property investment: Cash on Cash Returns (CoC). This post will not only dissect what CoC means, how it's calculated, and why it's vital for making informed investment decisions, but also show you how our real estate developer financial model templates can help you calculate cash on cash returns for various types of real estate investments.
In this article I plan to cover the following:
With that as our guide, let’s dive in!
Cash on Cash return (CoC) is a rate of return often used in real estate transactions that calculates the cash income earned on the cash invested in a property. It's an essential metric for investors to understand because it provides a clear picture of the investment's performance.
The CoC return is calculated by dividing the property's annual pre-tax cash flow by the total cash invested. Essentially, it's the ratio of annual income to the amount invested, expressed as a percentage. This measure is particularly useful for real estate investments because it takes into account the fact that most properties are purchased with a combination of debt and equity.
For example, if you purchase a property for $100,000, putting down $20,000 as a down payment, and the property generates $3,000 in annual net income, your cash on cash return would be 15% (i.e., $3,000 divided by $20,000).
This metric is crucial as it allows investors to compare the performance of different investment opportunities and to assess the risks and returns associated with each one. It's a straightforward and effective tool for determining the profitability of an investment property.
What is CoC in Real Estate?
CoC in real estate refers to cash on cash. Typically this would be referencing the cash on cash return of a real estate investment.
Calculating the Cash on Cash (CoC) return is a relatively straightforward process, but you'll need a couple key pieces of information:
- Annual Pre-Tax Cash Flow: This is the amount of money the property generates in a year after operating expenses but before taxes. This includes rental income and any other income the property generates minus expenses such as management fees, insurance, repairs, vacancies, and mortgage payments. If you are looking to calculate the historic cash on cash returns of an existing investment, then you can pull this information from your financial statements or tax returns.
Oftentimes investors are looking for the potential cash on cash returns of a proposed real estate investment. In that case you are going to need to create a real estate pro forma which is a set of projections for the real estate project that will ultimately allow you to calculate a forecasted cash on cash return.
- Total Cash Invested: This is the total amount of cash you have invested in the property. It typically includes the down payment, closing costs, renovation costs, or any other upfront costs necessary to acquire and prepare the property for renting. To be clear, this would not include any loans or debt used for the property.
With these numbers in hand, you can calculate the CoC return with the following formula:
Cash on cash return formula
Cash on Cash Return = (Annual Pre-Tax Cash Flow / Total Cash Invested) x 100%
Let's illustrate with an example.
Suppose you buy a rental property for $200,000. You make a down payment of $40,000 and spend an additional $10,000 on closing costs and initial repairs, making your total cash investment $50,000.
Let's say this property generates $24,000 in annual rental income. After accounting for all expenses such as mortgage, repairs, insurance, vacancies, etc., your annual pre-tax cash flow comes to $6,000.
Using the formula, the CoC return would be:
Cash on Cash Return = ($6,000 / $50,000) x 100% = 12%
So, your cash on cash return on this property would be 12%. This means that each year, you're earning 12% of your initial cash investment back in profit. This doesn't account for potential appreciation in the property value, which could also contribute to your overall return on investment.
Cash on Cash (CoC) return and Internal Rate of Return (IRR) are both metrics used to evaluate the profitability of an investment, but they serve different purposes and offer different insights.
Cash on Cash Return measures the annual return the investor makes on the property relative to the amount of cash invested, expressed as a percentage. CoC does not take into account the property's future cash flow or value, nor does it consider the time value of money - that is, the concept that a dollar today is worth more than a dollar in the future due to its potential earning capacity.
CoC is a simpler metric to calculate and understand, making it a useful tool for a quick evaluation of an investment's performance, particularly for those new to real estate investing. However, because it only looks at a single year and doesn't account for changes in cash flow over time, it may not provide a full picture of an investment's potential.
Internal Rate of Return (IRR) on the other hand, is a much more complex metric that gives a more comprehensive view of an investment's potential profitability. IRR is the rate at which the net present value of all cash flows (incoming and outgoing) from an investment equals zero. In other words, it's the rate at which the value of the cash invested equals the value of the returns.
IRR takes into account both the timing and the amount of cash flows, and also the time value of money. This makes it a particularly useful measure when future cash flows are uneven or when they occur at different points in time.
However, IRR can be more difficult to calculate and interpret than CoC. It's often used by more advanced or institutional investors who have the resources to calculate and understand this more complicated metric.
Both CoC and IRR provide valuable insights, but they are used for different purposes. CoC is best for a quick, simple evaluation of an investment's performance, while IRR provides a more detailed and comprehensive analysis of an investment's potential profitability over time.
Download our Free Tool: IRR Calculator
A "good" Cash on Cash (CoC) return can vary significantly depending on several factors, such as the type of investment, the market conditions, location of the property, and the risk tolerance of the investor.
However, as a general rule of thumb, a CoC return between 8% and 12% is considered sound for a real estate investment. Returns in this range are often seen as a balanced blend of risk and reward. Higher returns may indicate a higher risk investment, while lower returns may suggest a safer, but less lucrative investment.
Keep in mind, real estate markets can be vastly different from one another. A CoC return that's considered good in one market may not be as impressive in another. For example, properties in high-demand areas may have lower CoC returns, but can offer other benefits such as steady appreciation and lower vacancy rates.
Average cash on cash returns in real estate
The average cash on cash return in real estate is 8 to 12% according to FortuneBuilders.
We wanted to look into different types of real estate to see if we could find sources that estimate the cash on cash returns for various property types. Of course what you can expect to earn will depend on a number of factors including how well you operate the property, the amount of leverage or debt you use, and the price you pay for the property to name a few. But just to do a bit of research for you, here is what we found:
Average cash on cash returns in multifamily real estate
The average cash on cash return in multifamily investments is 8%, but typically ranges between 5 and 10% according to Fair Winds Capital Investments.
Average cash on cash returns in commercial real estate
The average cash on cash return in CRE is between 4% and 8% according to an interview conducted by Lev.co with Walt Batansky, CFO of Avocat Group.
Average cash on cash returns in self storage investment
The average cash on cash return in self storage is 8% to 12% according to Janover.
Average cash on cash returns in the hotel industry
A typical cash on cash return for a hotel can be greater than 10% according to the Bigger Pockets Forum.
Average cash on cash returns for Airbnb rentals
The average cash on cash return for Airbnb rentals in the top 60 US cities was 7.47% according to a calculation conducted by Mashvisor.
It is very important to remember that your cash on cash return is only part of the potential return for a real estate investment. In order to understand your true potential return on investment, you need both the potential appreciation or depreciation of the property value as well as the cash on cash return. So although you might only generate a 5% cash on cash return on a property, if the property also appreciates in value by 8% per year, your total return on investment (ROI) is much higher than your cash on cash return.
If you are looking to calculate a forecasted return for a property, make sure to check out our various real estate acquisition pro forma templates that will allow you to model the acquisition, renovation and ultimately sale of your property in order to see potential returns. The screenshot below shows how you can calculate both IRR and CoC returns with our Multifamily property pro forma:
If you have any questions along the way we would love to hear from you!
