CoC or Cash-on-Cash Return is the rate of return commonly used in such transactions with regard to real estate which calculates the cash income generated from property investment. Also, it determines the investor’s yearly return that is generated from the property in accordance with such mortgage payments made in the same year. It is regarded as one of the most essential real estate Return on Investment (ROI) calculations and is reasonably simple to grasp.
For real estate investors, Cash-on-Cash Return represents the net cash flow amount that is generated by property as a proportion of the total amount of money invested. It is also a rate of return ratio which estimates the total money earned on the total money invested. The total cash generated is usually calculated using the yearly pre-tax cash flow or Annual Before-Tax Cash Flow.
Cash-on-Cash Return = Annual Before-Tax Cash FlowTotal Cash Invested
Where is Cash-on-Cash Return Used?
Cash-on-cash (CoC) Return is frequently utilized for property investments that involve long-term loan borrowing. Once loans are included with the property transactions, wherein most commercial or rental properties are, the real cash ROI may differ from the typical ROI.
What is the Calculation of Cash-on-Cash Return?
The pre-tax cash inflows which are collected by the investor, as well as the pre-tax cash outflows that are made by the investor are used in order to determine Cash-on-cash returns on a real estate investment. The whole return on investment is taken into consideration in traditional ROI calculations. Moreover, the Coc (Cash-on-cash) return solely considers the return on the money invested, allowing for a more precise assessment of the investment’s success.
Below is the cash-on-cash formula:
Cash-on-Cash Return = Annual Pre-Tax Cash FlowTotal Cash Invested
Since pre-tax cash flow is included in the formula and computation, the investor should be mindful of the investment’s tax status at all times. High taxes may wipe out any possible investment gains if the cash on cash return is weak.
Why is Tax Excluded from the Cash-on-Cash Calculation?
With Cash-on-Cash Calculation, the tax is related to the investor’s individual tax position. Regardless of the owner of an investment property, it is the same, however, the income tax amount that is paid varies depending on the investor. With that, by excluding such tax from the equation, it becomes easier to compare different real estate investment outcomes as well as investors.
What is a good Cash-on-Cash Return for a Rental Property?
There is no particular rule of thumb as to what makes a decent return rate. However, investors seem to agree that around 8 to 12 percent predicted CoC or Cash-On-Cash Return is indicative of a successful investment while others say that even around 5 to 7 percent of Return is fine and already acceptable. It is essential to know that the return rate has a big impact on the amount you spend out of pocket as well as how your cash flow is organized. New investors may begin with only small or low cash-on-cash return criteria and gradually raise their expectations as they gain more experience and a better understanding of such things to know and look for in a rental property. It is also important to know what your objectives are when it comes to investments.
What is the Practical Example of Calculation of Cash-on-Cash Return?
XYZ Development is planning to release a commercial space to several businesses so for instance, they have decided to make a purchase of commercial space amounting to $1million. $300,000 has been paid by the company as well as the required $25,000 for other fees while the remaining balance amounting to $700,000 was a mortgage taken from a bank.
One year has passed and the revenue from the rental property is amounting to $120,000 while the mortgage, principal repayment, as well as the payment for interest, is amounting to $35,000.
In order to calculate the Cash-on-Cash Return, you should first need to know the yearly cash flow made from the investment. The formula will be:
Cash Flow (Annually) = Rent Yearly – Mortgage Payments
With that, Cash flow (Annually) = $120,000 – $35,000 = $85,000
After that, you should know the total cash you have invested. To calculate that, the formula is:
Total Cash Invested = Downpayment + Other fees
Total Cash Invested = $300,000 + $25,000 = $325,000
Cash-on-Cash Return = $85,000 / $325,000 = 26%
What are the Terms similar to Cash-on-Cash Return?
There are a few terms that are similar to Cash-on-Cash Return such as:
- ROI
- IRR
- Cap Rate
- Cash Flow
1. ROI
Return on Investment or ROI is a presentation measure used in order to assess if the investment is both efficient and profitable, it also differentiates the number’s efficiency of such investments. Return of Investment (ROI) aims to directly evaluate the amount of profit made on a given investment in relation to its cost.
The difference between ROI and Cash-on-Cash Return is that Cash-on-Cash Return evaluates the amount of money an investment property will create. On the other hand, ROI reflects total wealth accumulation.
Below is the formula on how to calculate the Return on Investment.
Return on Investment = Current Value of Investment – Cost of InvestmentCost of Investment
There are some advantages associated with Return on Investment such as:
- Multiple Projects: It enables organizations to assess numerous projects’ profitability from highest to lowest. The hierarchy of the investment allows management to deploy funds.
- Simple and clear: Calculating ROI is very straightforward and simple as well which makes it easy for everyone without any background in accounting.
- Compare projects: Compare both internal and external projects for you to maximize the whole profit of the organization or company.
- Maximize profit: Maximizing the profit with the limited resources available.
There are also a few disadvantages such as:
- Different Types of Calculations: Calculating the ROI may differ depending on companies or organizations for a reason that they may make use of various components in order to get the Return on Investment.
- Ignore the concept of money’s time value: The money’s time value is not included in the ROI for a reason that if it is included, the project may not be profitable.
2. IRR
IRR means Internal Rate of Return which means that it is a financial research indicator that is used in order to assess the profitability of new investments. Also, in the analysis of discounted cash flow, it is considered a discount rate for a reason that it makes the NPV equal to zero from all cash flows.
The calculation for IRR is the same as NPV. However, you have to be aware that IRR is not the project’s real value in dollars. The annual return is what brings the NPV to zero. Moreover, in order for the investment to be more appealing, the internal rate of return or IRR must be higher.
Furthermore, the difference between the Internal Rate of Return and Cash-on-Cash Return is that IRR considers all cash flows over the whole holding period while the Cash-on-Cash Return only considers cash flow from a specific year.
Below is the formula as well as the calculation of IRR.
0 = NPV = t=1TCt(1+IRR)t – C0
With the formula given, you should set NPV to zero and then solve the IRR or the discount rate. Keep in mind that the first investment is naturally negative since it is considered an outflow. IRR must be calculated through excel or trial and error.
IRR has some advantages such as:
- Determines the Time Value of Money: Since the timing of cash flow is considered in all future years, so with this so-called time value of money, each cash flow is represented equally.
- Simple and easy to understand: The IRR is easy to calculate and gives a straightforward way to compare the value of several projects or operations.
- It is not necessary to use hurdle rate: Hurdle Rate is not required with the Internal Rate of Return (IRR) method since it may result in a wrong rate.
On the other hand, the few disadvantages are:
- Ignore Project Size: When comparing projects, the IRR approach does not take project size into account. However, the smaller project has a larger IRR.
- Ignores Rate of Reinvestment: Calculating the future cash flow value assumes that cash flows could also be reinvested at the same rate as the Internal Rate of Return (IRR). However, that assumption is unrealistic.
- Ignore some Future Costs: The IRR technique solely considers the predicted cash flows created by capital investment and ignores any potential future costs that may have an impact on profit.
3. Cap Rate
Cap Rate or Capitalization Rate is a term used in the commercial real estate world in order to describe the projected rate of return on property investment. It is most commonly used to identify the different investment opportunities. Cap rates can also establish trends and these trends can indicate where the market is likely to head.
The difference between Cap Rate and Cash on Cash Return is that the Capitalization Rate determines the profit potential of a project without taking into account the cost of capital. While on the other hand, Cash-on-Cash Return informs you the amount of money you make for every dollar you invest in.
The formula for Cap Rate is below:
Capitalization Rate = Net Operating IncomeCurrent Market Value
The cap rate value compensates for the income property’s operational expenditures and vacancies, which results in a more realistic and true assessment of the estate’s performance. The downside of utilizing the cap rate that is used to evaluate an income property would be that finding the value of the cap rate for a property that is already sold is difficult.
4. Cash Flow
The total sum of cash, as well as cash equivalents being moved in and out of a corporation, is referred to as cash flow. Inflows are the cash or money received, whereas outflows are the money spent.
The difference between Cash Flow and Cash-on-Cash Return is that Cash-on-cash Return is measured in percentages, whereas cash flow is measured in dollars. Cash flow also tells you how much money you will have left to transfer at the end of the day into your bank account excluding income tax.
Below is the formula for cash flow.
Free Cash Flow = Operating Cash Flow – Capital Expenditures
There are different ways or methods in order to calculate free cash flow and regardless of the technique employed, the final figure should be the same.
The advantages of Cash Flows are as follows:
- Examine the Company’s Liquidity Situation: The cash Flow Statement provides information about the firm’s liquidity which the profit, loss, and funds flow statement do not provide.
- Assist with budget, plan, and control of the project: It supports top executives in coordinating financial activities appropriately.
- Money Transfers: Cash Flow statements show both the inflows and outflows of cash in which the cash flows from future forecasts may be built.
- Appraisal of Performance: By comparing current cash flow statements to forecasted cash flow statements, the management may assess cash performance.
The disadvantages of Cash Flows are as follows:
- Impossible Industry Comparison: It does not assess the firm’s efficiency, therefore comparisons with other industries are impossible.
- The Liquidity Position is not properly assessed: The statement of Cash Flow does not analyze the firm’s liquidity for a reason that it simply shows the financial position on a certain day.