Definition
Cash-on-Cash Return, also known as the cash yield, is a financial metric used primarily in real estate transactions. It measures the annual before-tax cash flow generated by an investment relative to the amount of cash initially invested. The formula for calculating Cash-on-Cash Return is:
\[ \text{Cash-on-Cash Return} = \left( \frac{\text{Annual Pre-Tax Cash Flow}}{\text{Total Cash Investment}} \right) \times 100 \]
Key Features:
- Annual Pre-Tax Cash Flow: This is the income produced by the property before any taxes are taken out.
- Total Cash Investment: This includes the total amount of cash invested in purchasing the property.
Examples
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Example 1:
- Investment: $10,000 investment in a rental property.
- Annual Pre-Tax Cash Flow: $1,000.
- Calculation: \[ \text{Cash-on-Cash Return} = \left( \frac{1,000}{10,000} \right) \times 100 = 10% \]
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Example 2:
- Investment: $50,000 in a commercial property.
- Annual Pre-Tax Cash Flow: $4,000.
- Calculation: \[ \text{Cash-on-Cash Return} = \left( \frac{4,000}{50,000} \right) \times 100 = 8% \]
Frequently Asked Questions
What is Cash-on-Cash Return used for?
Cash-on-Cash Return is used primarily to evaluate the profitability of income-producing properties and to compare the performance of different investments.
How does Cash-on-Cash Return differ from other yield measures?
Unlike other yield measures like Internal Rate of Return (IRR) or Yield to Maturity (YTM), Cash-on-Cash Return only considers the cash flow and initial cash investment, ignoring variables like financing costs and the timing of cash flows.
Is Cash-on-Cash Return a comprehensive measure of investment performance?
No, Cash-on-Cash Return is a simple metric and does not account for factors like appreciation, loan amortization, or tax benefits. It provides an immediate picture of annual return relative to cash invested but should be used in conjunction with other metrics.
Can Cash-on-Cash Return change over time?
Yes, it can change based on variations in annual cash flow or additional investments in the property.
Is a high Cash-on-Cash Return always preferable?
Not necessarily. While a higher Cash-on-Cash Return indicates better cash flow performance, it doesn’t guarantee overall investment quality. It’s important to consider other factors like property condition, market conditions, and long-term profitability.
Related Terms
- Internal Rate of Return (IRR): A financial metric used to evaluate the profitability of an investment, considering the time value of money and future cash flows.
- Yield to Maturity (YTM): A concept used primarily in bond investments, representing the total return anticipated on a bond if held until it matures.
- Return on Investment (ROI): A broader measure of performance that calculates the return of investment as a percentage of the original amount invested.
Online References
Suggested Books for Further Studies
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“Real Estate Investing for Dummies” by Eric Tyson and Robert S. Griswold
- This book provides an easy-to-understand guide on the basics of real estate investing.
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“The Millionaire Real Estate Investor” by Gary Keller
- A comprehensive guide on becoming a successful real estate investor, including key financial metrics like Cash-on-Cash Return.
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“Commercial Real Estate Analysis and Investments” by David M. Geltner and Norman G. Miller
- A detailed reference book focusing on the analytical and investment aspects of commercial real estate.
Fundamentals of Cash-on-Cash Return: Finance Basics Quiz
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