Among the many metrics used in commercial real estate, cash-on-cash return is particularly useful to gauge the rate of return of a transaction. Keep reading to learn more about cash-on-cash return, from how to calculate it to when to use it.
What Is Cash-on-Cash Return?
Cash-on-cash return (also known as “CoC return” or the cash yield of a property) is a metric used in commercial real estate to determine the cash earned on the cash invested in a property that generates income.
This is one of a handful of indicators (together with others like cap rate and NOI) that every person involved in commercial real estate should be familiar with.
At first sight, the formula to calculate cash-on-cash return looks simple. All you have to do is to divide the total cash invested by the annual pre-tax cash flow and then multiply the result by 100:
CASH-ON-CASH RETURN = (Annual pre-tax cash flow / total cash invested) X 100
However, you have to keep in mind that the annual pre-tax cash flow is obtained by adding gross rent and other income and then subtracting vacancy, operating expenses, and annual mortgage payments.
ANNUAL PRE-TAX CASH FLOW = Gross rent + Other income – (Vacancy + Operating expenses + Annual mortgage payments)
Why Is Cash-on-Cash Return Useful?
It’s easy (and normal) to feel cast adrift when faced by many indicators and metrics used in commercial real estate.
Things get a lot easier, however, when you get a basic grasp of when and how to use each metric.
For example, cash-on-cash return is useful for transactions that involve a considerable amount of debt (which is usually the case in commercial real estate) because it focuses on the actual cash invested.
Other metrics, like Return on Investment (ROI) include all the debt in a transaction, rendering them less useful if your purpose is to gain a sense of the actual cash return of a property.
As useful as it is, there are some caveats to keep in mind when using cash-on-cash return. For example, CoC return provides a one-year snapshot of the return generated by a property, so it must not be used as the sole parameter in your decision-making.
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