The real estate investment industry is expanding daily with new interests coming into the market. New investors are getting interested, especially around this period because of the varying prices, which are predicted to end up being in favor of investors and buyers. Making financial calculations in times as this can be quite intimidating for newbies in the market, especially when they are faced with multiple calculations that need to be done in the industry. One of the most important calculations is cash-on-cash return, which most investors find difficult to get right.
WHAT IS CASH-ON-CASH RETURN
Cash-on-cash return is expected on investment just before the tax and other earnings are calculated. This is the investor’s annual gain and depends on the amount that the investor has chosen to invest with. The same way the dividend is calculated in the stock market is how the cash-on-cash is calculated in the real estate industry.
As much as the cash-on-cash return can seem intimidating, it is amazingly easier to calculate than the other financial calculations that need to be done in the industry. It is essential to define some factors before going to explain how to calculate the cash-on-cash return.
The first is the annual pre-tax cash flow, the Net Operating Income of the property you have gotten as an investor, minus the debt service payments, and the capital expenditures.
The other point to be noted is the total cash invested, and this is the cash invested in the project minus debt financing. This is also called the equity in the deal.
For instance, an investor with a massive rental revenue will have to subtract the annual operating expense and mortgage payments before getting the pre-tax cash flow’s actual value. On the other hand, the total cash invested, is the total amount the company spent on investment without factoring in the loans used in financing the deal.
With this in mind, the simple formula used to calculate the cash-on-cash return is:
Cash-on-cash return = Annual pre-tax cash flow / total cash invested
LIMITATIONS OF CASH-ON-CASH RETURN
Cash-on-cash return is not a fixed amount, and investors need to bear this in mind while making the calculation. This is because it does not factor in payments such as coupons and debt payments. These payments need to be made by investors irrespective of the market variations. This means that the cash-on-cash return is only projected, as the actual amount cannot be known until the end of the year.
Rents and revenue may remain constant during the year or even vary in favor of the investor; however, the debt coupons and other payments that need to be made by the investor still end up affecting the amount of cash-on-cash return more.
The fact that the value of cash-on-cash return is the only speculation does not mean that it should not be known. Most times, the actual value only has a little difference compared with the calculated value of this return.