Cash-on-cash return explained

What cash-on-cash return is

Cash-on-cash return answers one plain question. For every dollar of my own cash that I put into this deal, how many cents come back each year as cash flow?

It looks at real money only. It uses the cash left after the loan payment, and it divides by the cash you actually paid out of pocket. That makes it different from cap rate, which ignores the loan. If you finance the deal, cash-on-cash return is usually closer to what lands in your bank account.

You may also see it called cash yield or cash return on cash invested. They mean the same thing.

The formula

NOI is net operating income. It is collected rent minus operating costs such as taxes, insurance, repairs and management. Loan payments are the principal and interest you pay in a year. What is left is your cash flow before income tax.

What counts as cash invested

The bottom of the formula is where people slip. Count every dollar you spend to get the deal running, not just the down payment.

• The down payment.
• Closing costs.
• Repairs or upgrades you pay for before the first tenant moves in.
• Any reserve you set aside up front, if you want a stricter number.

Do not count the loan. The loan is the bank's money. Do not count the monthly payments either, because those are already inside the cash flow on top of the formula.

Worked example

These are made-up round numbers, not the calculator's starting numbers. I ran them through the rental cash flow calculator's math to check each line.

Price: $200,000. Down payment: 25%. Closing costs: 3%. Upfront repairs: $4,000. Loan: 7% for 30 years. Rent: $2,000 a month. Vacancy: 5%. Property tax: 1.2% of price. Insurance: $1,200 a year. Repairs and CapEx: 5% of rent each. Management: 8% of collected rent.

• Cash invested: $50,000 down + $6,000 closing + $4,000 repairs = $60,000
• Loan: $150,000. Payment: $997.95 a month, or $11,975 a year
• Collected rent: $24,000 - $1,200 vacancy = $22,800
• Operating costs: $2,400 tax + $1,200 insurance + $1,200 repairs + $1,200 CapEx + $1,824 management = $7,824
• NOI: $22,800 - $7,824 = $14,976
• Cash flow: $14,976 - $11,975 = $3,001 a year, about $250 a month
• Cash-on-cash return: $3,001 / $60,000 = 5.00%

For the same deal, cap rate is $14,976 / $200,000 = 7.49%. The cap rate is higher because it ignores the loan. At a 7% loan rate, borrowing eats most of the income, and the cash-on-cash return comes out lower.

Cash-on-cash return vs cap rate

Both numbers use NOI, but they answer different questions.

• Cap rate compares the property to its price and ignores financing. Use it to compare properties. See what is a good cap rate.
• Cash-on-cash return compares your cash flow to your cash and includes financing. Use it to judge your own deal with your own loan.

When the loan rate is above the cap rate, borrowing more tends to push cash-on-cash return down. When the cap rate is well above the loan rate, borrowing tends to push it up. That is the idea of leverage, and it cuts both ways.

What is a good number?

There is no single good cash-on-cash return. A fair rule of thumb is to ask what else you could do with the same cash. If a savings account or index fund could pay you something close, a thin return on a rental has to be worth the extra work and risk.

Many investors set their own minimum before they shop, then walk away from deals under it. Pick yours, write it down, and apply the same expense rules each time. Be extra careful with deals that look great only because the expenses were left light.

When it misleads

• It is a year-one snapshot. Rent, taxes and insurance move over time.
• It leaves out loan paydown, price growth and tax effects. A rental with a low cash return can still build wealth through those.
• It swings with how much you put down. Less cash in makes the percentage look better, even when the deal itself is no better. Compare the dollars too, as in how to calculate rental cash flow.
• If almost all your cash comes back out through a refinance, the return can look huge or undefined. The BRRRR method has its own way to read that.

Ways to raise it

The formula shows the levers. You can raise rent, cut operating costs, get a lower rate, or put in less cash. Each lever has a limit and a cost, so test one change at a time in the calculator and watch the dollars, not only the percent.

FAQ

Is cash-on-cash return the same as ROI?

Not quite. ROI is a broad term. Cash-on-cash return is one narrow version of it: annual cash flow divided by cash invested, before tax and before loan paydown or price growth.

Should I include principal paydown?

The standard formula does not. Your payment includes principal, so it lowers cash flow. Some investors add paydown back as a separate gain. Keep the two numbers apart so you can see each.

Can cash-on-cash return be negative?

Yes. If NOI is smaller than your loan payments, cash flow is negative and so is the return. That means you pay in cash each month to keep the property.

Do I use pre-tax or after-tax cash flow?

The usual formula uses pre-tax cash flow. Taxes depend on your own situation, so ask a tax professional about yours.