Cash On Cash Returns: Calculator, Risks Involved
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The definition of cash on cash returns can be simplified as follows; cash on cash return is a rate of return commonly used in multifamily and commercial real estate finance. It is calculated by looking at the amount of cash you invested compared to the amount of income you received over a specific time period, generally one year.
Simply, cash on cash return is calculated by dividing annual income by total investment. Cash on cash return is also called the equity dividend rate in certain cases. This is one of the most common return systems that can be found in the real estate industry. Referring to the example mentioned above, you can see it is a ratio, which is converted in to a percentage.
Cash on Cash Returns Calculator
Knowing the formula, you should realize that the cash flow figure equals the net operating income of the property. Usual operating expenses should be deducted from the gross rental income. Then the answer should be divided by the equity investment to get the cash on cash return.
Income tax effects, resale implications, future cash flows, and loan principal deductions are not taken into consideration when we measure the cash on cash return.
The cash-on-cash aspect can be utilized to figure out the effects of leverage. In general, leverage is created by using a commercial mortgage loan to finance a portion of the property’s purchase value. For instance, assume an investor is able to secure a $600,000 mortgage loan on a $1,000,000 acquisition. Although debt repayment expenses like interest and other costs are going to occur, in this case a remarkably lesser investment is required and hence the additional expenses can be considered as worthwhile ones. Instead of buying a $1,000,000 property with $1,000,000 cash, you are buying it with $600,000 debt and only $400,000 cash and therefore your cash-on-cash returns will measure results on an overall investment that is the same size, but your cash outlay being significantly less.
Risks Involved
This indicates if you can finance a greater portion of the property’s purchase value you can increase the cash on cash return. However, loans always involve a certain amount of risk. If the projected net operating income decreased substantially, the owner may be liable to make principal and interest payments or even, at some point, pay back the entire loan prematurely.
An investment in commercial real estate, of course, is a subject to be studied thoroughly prior to making any decision. Income taxes, possible risks, the amount of money to be borrowed, and the various financing alternatives available are the key components to consider before making a decision.
Related Questions
What is a cash on cash return in commercial real estate?
Cash on cash return is a rate of return commonly used in multifamily and commercial real estate finance. It is calculated by looking at the amount of cash you invested compared to the amount of income you received over a specific time period, generally one year. To calculate the cash on cash return, an investor first determines the net income from a specific property for the year. They can do this by determining the gross income the property generated and then subtracting any operating costs (and in the event there is a commercial mortgage, debt service as well). Then, they should divide the net income by the total cash spent for the property. The resulting figure, once converted to a percentage, is the cash on cash return.
Cash on cash return can be calculated by using the following formula:
Cash on Cash Return= Annual Dollar Income / Total Dollars Invested
For more information, please refer to this article and this article.
What are the risks associated with cash on cash returns in commercial real estate?
The risks associated with cash on cash returns in commercial real estate include the possibility of decreased net operating income, which could lead to the owner being liable to make principal and interest payments or even, at some point, pay back the entire loan prematurely. Additionally, income taxes, the amount of money to be borrowed, and the various financing alternatives available are all key components to consider before making a decision.
For more information, please refer to this article and this Wikipedia page.
How can I calculate the cash on cash return for a commercial real estate investment?
You can calculate the cash on cash return for a commercial real estate investment by using the following formula:
Cash on Cash Return = Annual Dollar Income / Total Dollars Invested
To calculate the cash on cash return, an investor first determines the net income from a specific property for the year. They can do this by determining the gross income the property generated and then subtracting any operating costs (and in the event there is a commercial mortgage, debt service as well). Then, they should divide the net income by the total cash spent for the property. The resulting figure, once converted to a percentage, is the cash on cash return.
For more information, please refer to the following sources:
What factors should I consider when evaluating a cash on cash return in commercial real estate?
When evaluating a cash on cash return in commercial real estate, you should consider the following factors:
- The amount of money to be borrowed
- The projected net operating income
- Income taxes
- The various financing alternatives available
- The amount of cash required to enter into a commercial real estate investment
It is important to study these factors thoroughly prior to making any decision. The cash on cash return calculation is used as a basic yardstick for assessing a possible real estate investment and is determined by dividing the net income from a specific property for the year by the total cash spent for the property. The resulting figure, once converted to a percentage, is the cash on cash return.
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What are the benefits of investing in commercial real estate with a cash on cash return?
The benefits of investing in commercial real estate with a cash on cash return include the ability to quickly assess the potential return on investment, as well as the ability to leverage the investment with financing. Cash on cash return is a rate of return commonly used in multifamily and commercial real estate finance. It is calculated by looking at the amount of cash you invested compared to the amount of income you received over a specific time period, generally one year. This makes it easier to compare different investments and determine which one is the most profitable. Additionally, financing can be used to increase the cash on cash return, as it allows you to purchase a larger property with a smaller down payment. However, it is important to consider the risks involved with financing, such as the possibility of decreased net operating income or the need to pay back the loan prematurely.
What are the best strategies for maximizing cash on cash returns in commercial real estate?
The best strategies for maximizing cash on cash returns in commercial real estate include:
- Maximizing the amount of money borrowed to finance the property purchase, while still ensuring that the loan is affordable.
- Ensuring that the projected net operating income is accurate and reliable.
- Researching and understanding the various financing alternatives available.
- Considering income taxes and other possible risks.
For more information, please refer to this article.