CASH ON CASH RETURN

Cash on cash return is used to determine how much percent return on my cash I estimate to make in the future or how much I actually made in the past.

There are two types of cash on cash return calculations:

1. CASH ON CASH RETURN WHEN I BOUGHT / WILL BUY THE PROPERTY CASH WITH NO MORTGAGE.

2. CASH ON CASH RETURN WHEN I BOUGHT/WILL BUY THE PROPERTY WITH A MORTGAGE.

CASH ON CASH RETURN WHEN I BOUGHT / WILL BUY THE PROPERTY CASH WITH NO MORTGAGE

Example: You own an investment property that you bought a year ago for $200,000. Let's say that the You calculated that in the past 12 months your net income after all the expenses (excluding principal and interest expenses) was $16,000. This net income is also usually being refereed to as NOI or NET OPERATING INCOME (calculated on an annual basis)

In order to find the CASH ON CASH RETURN you simply take the NOI ($16,000) and divide it by the cost of the property you bought all cash which is $200,000 so you come up with a percentage. In this example the cap rate is 8, which means that your $200,000 made you a $16,000 annual profit which is to my opinion not a bad but also not good enough of a return.

It doesn't mean that the property itself is not a good investment (quite the contrary) but rather that because you didn't buy the property with some kind of financing (also called financial leverage) - your return on the money was only 8% because it lacks that financial leverage.

CASH ON CASH RETURN WHEN I BOUGHT/WILL BUY THE PROPERTY WITH A MORTGAGE

Now, if I would be you a year ago I would say that in order for me to make the maximum amount of profit / return on this $200,000- I would have split this amount of $200,000 to 4 pieces of $50,000.

Each $50,000 will be used as a down payment to buy a total of 4 income properties (the remaining $150,000 will come in a form of a mortgage), so after owning these 4 properties for a year- I would like to know how much profit / return this leveraged investment will yield to me.

For the simplify, lets say that each property generated a NET OPERATING INCOME (NOI) of $16,000 like the other example above.

CASH ON CASH RETURN FOR A LEVERAGED PROPERTY is the NOI minus the cost of the interest I paid (let's say it was $7,500 interest cost which is 5% interest rate for a $150,000 mortgage) divided by the amount of the cash out of pocket expense when I bought the property (the down payment for the most part) so..

$16,000-$7,500=$8,500 yearly profit / $50,000= 17% is the CASH ON CASH RETURN.

So you see how getting a mortgage more then doubled the return for a similar performing property.

Now,if you remember i bought 4 of these properties so the profit will be 4*$8,500= $34,000

so the cash on cash return for all of this $200,000 cash investment is $34,000/$200,000= 17%

Isn't it much nicer making $34,000 annual profit vs only $16,000 on the same investment amount?

CAP RATE

Cap rate (also called as capital rate) is how much percent of return you are getting typically IF YOU ARE SELLING OR WANT TO SELL THE PROPERTY

The formula goes like that: You take the NOI (with NO interest cost) and divide it by the VALUE of the property that it's worth TODAY.

Notice that we are not looking for the amount that the property has cost you, but rather the value of it today after you have purchased it.

Since interest cost varies from investor to an investor we will exclude this cost exactly like the buyer would buy the property all cash even if the buyer wouldn't buy the property all cash.

let's say that after two years the property that I bought for $200,000 now is worth $250,000.

The calculation will be: NOI ($16,000)/$250,000= 6.4%.

How much was the cap rate just before i bought the property two years ago?

Answer: $16,000/ $200,000= 8%

For simplicity I'm Assuming that the rents were the same when i bought the property to what they are now, which is never the case cause usually I do increase the rents (create value add), but you got the picture.

Return on equity

In order to find the Return on equity percentage , let's remind ourselves that equity is simply THE VALUE OF THE PROPERTY TODAY MINUS OUR DEBT (if the debt is 0 so just deduct 0).

Lets go back to the example that we have a property that we bought a year ago for

INTERNAL RATE OF RETURN (IRR)-