In an attempt to give more ongoing foundational information to prospective buyers and tenants, we’re going to continue on with a series of posts defining core terms in commercial real estate. Our “CRE Terms You Need to Know,” officially kicks off here.
There are a multitude of metrics that commercial real estate investors use to help them determine the profitability of a property and the strength of their investment strategy. Each metric showcases a different potential outcome of an investment and tells a different story. Let’s dive into one of the most commonly used metrics — cash on cash return.
Cash on cash return is the amount of cash flow in your pocket based on the amount of cash you invested in the property. It’s most commonly calculated annually, but can be broken down into any time frame based on the individual investor’s needs. Unlike net operating income (NOI) or return on investment (ROI), cash on cash return takes into account the amount paid on a property’s mortgage — important, considering the majority of real estate investors rely on long-term borrowing to finance their properties. While metrics like ROI can tell you your total returns, cash on cash return can tell you the percentage you are receiving back based on the amount of cash you put in (not based on the total value of the property).
Cash on cash return is calculated before taxes, but after financing (mortgage). To determine cash on cash return rate, you take your annual pre-tax returns on your property, divided by the total amount invested in the property.
Cash on Cash Return = Annual Pre-Tax Cash Flow/Total Cash Amount Invested
You can determine your annual pre-tax cash flow by adding your tenant’s rent payments and other income (such as paid parking, vending machines, etc.) and then subtracting any vacancies you have, your gross operating expenses and your mortgage payments.
Cash on cash return provides an accurate and tangible picture of an investment’s overall performance. Whereas ROI looks at the overall return on an investment (including any debt), cash on cash return analyzes the return on the cash the investor contributed. This provides important feedback on individual investment strategy and can be used to help forecast future earnings and expenses.
Confused? We can help.
At NAI, our experienced brokers can help you evaluate your needs, compare investment strategies, and negotiate the best deal for you. Contact our team today to find out more about how we can help you with your commercial real estate needs.