When purchasing a commercial real estate property, every investor needs to account for the amount of income and expenses he can expect from the asset. The cash on cash return is a metric that can help investors identify whether a particular real estate property is within their budget or not.
Definition of cash on cash return
Cash on cash is defined as the rate of cash return a real estate property receives for the total cash it has invested.
Here, buyers calculate how much money they may need to invest in a particular period of time and how much they’ll get back in return.
Cash on cash return is calculated using the below formula:
NET CASH FLOW / CASH INVESTED = CASH ON CASH RETURN
Net cash flow: Cash in hand left after expenses are deducted. The expenses here refer to utilities, landscaping, cleaning services, security hire, pest control, and so on. Any interest on borrowings and costs involved in borrowing will also need to be subtracted. However, the expenses exclude tax payments.
Cash invested: This includes the entire capital used to purchase the property, in addition to mortgage costs and the costs of any inspections, repairs, or renovations you may have done. But you shouldn’t include the principal payment over the term of the loan.
Most investors agree that good cash on cash return is somewhere between 8%-12% for a real estate property.
How cash on cash differs from IRR & Cap rate
Cash on cash return adds immense value to other metrics and allows the buyer to consider the real estate property from multiple angles before buying it. But to understand the value cash on cash offers, we need to understand how it differs from other metrics.
IRR: The IRR considers the cash flows for the entire duration of ownership of the property. This is different from the cash on cash return metric, which provides details about cash flow only for a duration of one year. Through this, the cash on cash return metric provides a granular look at what buyers can expect from annual cash flows, should they buy the property.
Cap rate: The cap rate is a fairly standardized rate of return for all investors interested in purchasing the same or similar property. This is because it doesn’t consider very investor-specific factors like mortgage payments, choice of repair/security/landscape provider, and so on. Investors can sometimes forget that other expenses and cash flows may also be involved. The cash on cash return metric is very investor-specific and changes depending on the buyer. Because of this, cash on cash return helps investors make more mindful decisions by becoming aware of all the investments and earnings they will encounter by investing in the property.
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Using the cash on cash return metric for multifamily property investing
Multifamily property is often purchased for long-term investment, with a view to rent out the units and make a living through rentals. When an investor plans to purchase a multifamily real estate, they need to consider the impact of such a long-term investment on their day-to-day expenses and the amount of cash needed to fuel this purchase.
This is where cash on cash return metric helps.
This metric allows investors to:
- Calculate the total expenses of the multifamily property for the entire year.
- Identify whether the commercial real estate is within their budget and can be maintained without problems.
- Identify and select properties that cost less to acquire or need the least cash investment for repairs.
- Decide the need for financing to purchase the multifamily property & the type of financing to secure.
– The Multifamily Review Team
Hi, my name is Michael Avent. I founded The Multifamily Review in 2020. I’m a Commercial Agent at Northcap Multifamily located in Las Vegas, Nevada. My vision for The Multifamily Review is to be the most trusted resource for all Multifamily Investors and Industry Professionals. We strive to offer the best and most up to date content to our readers and are always open for suggestions. Make sure you sign up to join our newsletter to stay up to date on our latest blog, ebook, and more exclusive content that’s coming your way! The Multifamily Review team and I look forward to building a deeper relationship with you!
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