What is Cash on Cash Return on Investment?
Cash on Cash Return on Investment, often abbreviated CoC or Cash on Cash or Cash on Cash Return or Cash on Cash ROI is the percentage return you get on the cash you have invested in the deal.
For example, if you invested $10,000 to purchase a property and you're getting $1,000 per year in net cash flow after all your expenses, then you're seeing a 10% cash on cash return.
It gives you an idea of how well your property is cash flowing and what return you're getting for the amount of money you actually invested in the property.
How do I calculate Cash on Cash Return on Investment?
Cash on Cash is calculated by taking your net cash flow on the property after all your expenses and dividing it by the amount of cash you invested in the property to make your purchase.
We might describe that as:
Net Cash Flow After All Expenses
Total Cash Invested
Total Cash Invested
It is pretty easy to calculate the Total Cash Invested; it is your down payment plus any closing costs you were required to pay for out of pocket (not financed or paid for by the Seller) and any rent ready costs you might have to get the property ready to rent.
Lease Option Fees and Cash on Cash ROI
If you're having a lease option tenant buyer give you an upfront lease option fee when you buy the property, you may also decide to treat this in one of two ways. First is you could consider it a rebate or credit on the amount of cash you need to do the deal. This would reduce your Total Cash Invested which typically magnify your cash on cash return for the first year and subsequent years.
A second way you could look at an upfront lease option fee is to consider it additional cash flow on the property in that first year. This would improve your Net Cash Flow After All Expenses and improve your cash on cash return on investment for the first year only.
Net Cash Flow After All Expenses
When calculating cash on cash return on investment we are not taking the gross rent as our numerator. Instead we are figuring out what our cash flow is after all expenses have been subtracted from the gross rent for the year.
What expenses do you we typically account for? Here are a few of the most common: vacancy, property taxes (not income taxes), insurance (typically the landlord insurance policy), homeowner's association dues (HOA), any utilities that we are paying because they're not paid by the tenant, a maintenance reserve for doing maintenance on the property and property management fees if we are having it managed by a professional property manager. Of course, the largest expense is often the mortgage payment including principal pay down (if there is any) and interest.
Once we subtract those expenses from gross rent, we are left with a net cash flow after all expenses. That is what we use in the numerator when calculating cash on cash return.
What's a reasonable Cash on Cash Return on Investment with 20% down?
Since there are many factors that go into calculating cash on cash return it is extremely hard to tell you what a reasonable cash on cash return should be when buying a property with 20% down.
I will give you an actual number that I personally use in Northern Colorado in a moment, but if you're in another market, you might be best served to look at cash on cash return for a very large number of properties. Become familiar with what is normal in your market over a large sampling of properties. Then, I'd recommend targeting the top 5 to 10% of properties that have great cash on cash returns while balancing that with selecting a quality property.
In many cases you'll be able to find better cash on cash returns with lower priced, lower quality properties. While you may be tempted to buy those based solely on the cash on cash returns, I'd encourage you to consider a balance between cash on cash return and quality. In other words, I'd be willing to sacrifice a little cash on cash return (not a lot) for a slightly better quality property that will be easier to maintain, easier to rent and is likely to appreciate in a good neighborhood.
So, getting back to the main question: what is a good cash on cash return with 20% down… in our local market in Northern Colorado, if you can get a property that has a 5% cash on cash return, I think you're in the top 5 to 10% of properties by cash on cash return.
What's a reasonable Cash on Cash Return on Investment with 5% down?
As the amount of money you put down decreases the volatility of cash on cash return increases. In other words, as you put a smaller amount down even the smallest changes in your net cash flow after all expenses have a big impact on your cash on cash return.
Like I mentioned when I talked about what a reasonable cash on cash return would be for 20% down, it is really hard for me to tell you what I think is reasonable for 5% too. However, I will give you some guidance in general and some even more specific guidance for our local market here in Northern Colorado.
First, some general guidance. If you were to pretend that you were putting 20% down and calculated cash on cash return on your investment and you were able to be in your top 5 to 10% of cash on cash returns for your marketplace that would be a good plan of attack. Then, change your spreadsheet to be the true 5% down that you are really going to use.
Remember, the way I think about buying Nomad properties and putting less than 20% down is that you're financing your down payment over time. That means any negative cash flow you had on the property is really just financing the down payment you would have put down in you put 20% down to begin with. So, we might expect poor cash on cash returns with significantly less than 20% down.
More specifically, in Northern Colorado if you can be less than $100 negative per month with 5% down I think that's acceptable. So, for a $300,000 property where you put down $15,000 (5%) instead of $60,000 (20%), you'd be making up the $45,000 difference at a rate of less than $100 per month, I'd be OK with that. It would take you 37.5 years at $100 per month to make up that difference and I'd rather see you save the $45,000 in cash reserves than to put up as a down payment.
What's a reasonable Cash on Cash Return on Investment with 3.5% down?
Just like I've previously discussed when I talked about 20% down and 5% down, it is really hard to give you a number for a reasonable cash on cash return in a vacuum. There are a lot of factors that go into the calculation which are market specific.
With that being said, just like the 5% down conventional financing with a 3.5% down FHA loan I'd still like to calculate the cash on cash return for 20% down and make sure it is in that top 5 to 10% of cash on cash returns in your local market. Again, you'd know that by running a spreadsheet on lots of properties to see what is normal and what would be the best 1 in 10 (that's top 10%) or best 1 in 20 (that's the top 5%). If it is in the top 5 to 10% with 20% down, then I'd be OK buying it with 3.5% down and financing the rest of the down payment over time.
Again, in my local market in Northern Colorado, I'd like to see you try to stay below $100 per month negative, but as you reduce your down payment the negative cash flow will likely increase as well. So, you'd expect a larger negative cash flow on a property with 3.5% down than 5% down.
What's a reasonable Cash on Cash Return on Investment with 3% down?
If I'm starting to sound repetitive from answering similar questions above, it is because I am.
With 3% down, you'd expect more negative cash flow than 5% down and 3.5% down, but as long as it the property would have looked good with 20% down, I'd personally be OK with financing the down payment over time.
What's a reasonable Cash on Cash Return on Investment with 1% down?
As your amount invested gets smaller and smaller the cash on cash return on investment becomes less meaningful. Even small changes in your cash flow cause wide swings in your cash on cash return.
So, I'd encourage you to look at what cash on cash return would have been with 20% down and make your decision based on that. Then, switch your spreadsheet to show the 1% down and double check to make sure that you're OK with the negative cash flow amount.
One other thing I will point out about the negative cash flow… I would also take into account the cash flow including the depreciation benefit.
What's a reasonable Cash on Cash Return on Investment with nothing down?
If you remember that our formula for calculating cash on cash return is:
Net Cash Flow After All Expenses
Total Cash Invested
So, what happens to cash on cash return as the Total Cash Invested goes to zero?
Well, if it was zero, then cash on cash return would be mathematically undefined. But, if you have positive cash flow, as the amount you invested goes to zero, the cash on cash return on investment approaches infinite. If you've ever heard someone say I have an infinite return on investment this may be what they're talking about.
However, and we are more likely to see this in our local market in Northern Colorado, if you have negative cash flow with nothing down, then you are approaching a negative infinite return on investment.
Take the same approach I mentioned above: calculate your cash on cash return on investment as if you put 20% down to see if you'd consider it and then readjust your spreadsheet to nothing down. Double check the dollar amount of your negative cash flow and see if you're OK with it. I'd be OK with up to about $150 per month negative cash flow with nothing down. Although, I'd look really hard at the class I did on how to improve cash flow to see if I could eliminate negative cash completely by implementing some of those ideas.
What affects Cash on Cash Return on Investment?
If we look at all the factors that go into calculating cash on cash return we can see everything that affects it.
Net Cash Flow After All Expenses
Total Cash Invested
What makes up Total Cash Invested
- Down payment
- Closing costs
- Seller concessions (they offset closing costs)
- Rent Ready Costs
- Lease Option Fee (if you're putting in a tenant buyer immediately which is not typical for Nomads)
What makes up Net Cash Flow After All Expenses?
- Rent (this is a big one)
- Your mortgage payment (including amount borrowed, interest rate, term, LTV because it affects PMI, points paid that may affect rate and the lender you use)
- Property Taxes
- Property Insurance
- Utilities (not paid by Tenant)
- Homeowner's association fees (HOA)
- Maintenance reserve on the property
- Property Management (if you're not doing it yourself)
So, adjusting any of these will have an impact on cash on cash return.
Does cash flow affect my Cash on Cash Return on Investment?
Yes, it is a major factor. Your cash flow after expenses is critical to determining your cash on cash return.
Is Cash on Cash Return on Investment guaranteed?
No. In fact it is one of the two most variable returns (along with appreciation). Because so many of the factors that make up cash on cash return can and do change, cash on cash return is likely not to be an exact return and it is definitely not, in any way, guaranteed.
Is Cash on Cash Return on Investment fixed for the entire life of the investment?
No. Cash on cash return will change over time. As many of the factors that make up cash on cash return change over time, so will cash on cash return. For example, as your rent changes over time so might property taxes, insurance, HOA fees and maintenance on the property. These all have a significant impact on your cash on cash return, so expect it to change over time.
Is Cash on Cash Return on Investment a good criteria for selecting properties?
Yes. I think cash on cash return is the primary selection criteria for Nomads selecting properties. Remember, as Nomads we are living in the property for a year then converting the property to a rental… that means the property should be selected with renting it in mind.
One of the best metrics to select investment properties would be to evaluate the cash on cash return on investment. So, as Nomads we definitely want to look at what the cash on cash return on investment would be and make decisions with that as a significant consideration.
Will my real estate agent calculate Cash on Cash Return on Investment for me?
Only a small fraction of real estate agents know how to run cash on cash returns. And the ones that do are still not likely to run cash on cash returns on properties for you.
In my local market, I provide classes and tools for my clients to run cash on cash return calculations on properties themselves, but typically I am not personally running cash on cash returns on properties for them. I do provide my clients with a spreadsheet.
Where can I search for properties by Cash on Cash Return on Investment?
You can use a tool like the one on Investability.com.
Do I need to know the rent to calculate Cash on Cash Return on Investment?
Yes, rent is a major factor in calculating cash on cash return. In many cases, it is challenging for people to estimate the rent on a property. And some real estate agents, like me, aren't always the best source of coming up with rent. I tend to be low on rent estimates.
How do I get rents to calculate Cash on Cash Return on Investment?
Since rent is such an important factor when calculating cash on cash return, it is a good idea to take some time to research rents on properties you're considering purchasing. So, where do you get what comparable properties are renting for?
One place is to look at recent ads on websites like CraigsList for your local market and look at properties that are like the one you're considering to see what they've been renting for.
In addition, there are some websites that try to estimate rent like Zillow, RentRange, RentOMeter and others. While they may be accurate sometimes, be careful and try to independently verify rents with multiple sources.
And finally, you may want to ask local property managers what the property might rent for.
Do I recalculate Cash on Cash Return on Investment each year?
I think it is a good idea to review your spreadsheet at least once a year or so to see how your properties are performing. By reviewing your numbers you may find opportunities to improve the numbers.
Do you use Cash on Cash Return on Investment to determine if you should refinance a property?
Most of the time we don't recommend refinancing properties as a Nomad, but there could be times where refinancing makes sense (like with an FHA loan to get rid of PMI once your LTV has dropped below 75-80%).
In those cases, running cash on cash return numbers for your current situation and financing and pro forma numbers on what the new financing might look like is both prudent and advisable.
Why do you use Cash on Cash Return on Investment and not Capitalization Rate?
Cash on cash return takes into account the cash flow on the property after all your expenses and the amount of money you needed to invest to get that cash flow.
Capitalization Rate (or cap rate as we often abbreviate it) is the net cash flow on the property if the property was owned free and clear.
I prefer to look at cash on cash return rather than cap rate since most Nomads will not be buying properties with all cash and the loan will have a significant impact on the return.
Does it matter what loan I get when calculating Cash on Cash Return on Investment?
Yes. The loan that you get will have a significant impact on your cash on cash return. Here are a few ways it will come into play.
- The amount you borrow will affect your cash flow which impacts cash on cash return.
- The amount you borrow will affect your Loan To Value (LTV) which often affects whether you will be required to have Private Mortgage Insurance (PMI). Having PMI will impact your cash flow which impacts your cash on cash return.
- The interest rate you get will affect how much your payment is which affects your cash on cash return.
- The amount of points you are willing to pay (or get a credit for) will impact your interest rate which affects cash flow which… as you might guess from above… affects your cash on cash return.
- The term of the loan (15 year or 30 year as examples), affects your payment amount which impacts cash flow and therefore cash on cash return.
Where can I get a calculator to figure out Cash on Cash Return on Investment?
There are probably several cash on cash return calculators available on the web. There are web based ones and spreadsheets you can download.
The Real Estate Financial Planner™ software also calculates cash on cash return and makes charts of it over time as well but it is not as easily accessible so I probably would not recommend that.
Is there a spreadsheet to calculate Cash on Cash Return on Investment?
Yes, we provide you with a spreadsheet that we use to teach classes from. So, you will be able to do your own calculations of cash on cash return (plus a bunch of other stuff) and we will be teaching you how to use it as we teach classes where we use it for the slides.
Is there a website that will calculate Cash on Cash Return on Investment?
The website Investability.com allows you to do similar things with properties in other parts of the country. I suspect there must be some other websites that allow you to calculate cash on cash return as well, but I am not aware of them.
What are reasonable assumptions for rent?
Rent varies from real estate market to real estate market and even property to property. Even properties that are similar and close to each other might have a factor or two that would get it a slight discount or slight premium on rent. So, it is really hard to give you a reasonable assumption for rent.
You will want to look up comparable rentals around the property you're considering to get an idea of rent to use and use that.
What are reasonable assumptions for vacancy?
In most markets, using 3-5% vacancy would be a reasonable assumption for vacancy. We teach Nomads to be super proactive in finding their next tenants 60 days prior to the property being vacant, which should significantly reduce the time that a property is vacant.
Combine the proactive seeking of tenants will thorough tenant screening and you should reduce your evictions as well keeping your vacancy low.
What are reasonable assumptions for interest rate?
For interest rate you should be getting pre-approved with your lender very, very early in the process. This should be before you really start looking at homes, so the best number to use is the estimated interest rate that your particular lender will be able to get for you when you purchase your property.
What are reasonable assumptions for maintenance?
Maintenance can vary from property to property in two important ways.
First, since we use a percentage of rent collected as our maintenance number, properties will lower rents (definitley below $1,000 per month) will tend to need to use a higher percentage of rent for maintenance. For these, I'd recommend as a really rough rule of thumb between 12 and 15% for maintenance. For rents about $1,000 I might suggest between 10% and 12%.
The quality and age of the property is another factor. For newer homes, rather than using 10 to 12% I might be OK with 8 to 10% in the first few years. With new construction with a warranty, I am completely comfortable using 8% knowing that all my major house components are at the beginning of their life cycles. I'd increase this number over time. For much older homes, like homes built prior to 1950, maintenance may be 15% or higher.
What are reasonable assumptions for property taxes?
For property taxes, we typically use the estimated taxes from the MLS as a first pass. If the property looks interesting, we might double check this assumption by looking up on the county assessor's website the most recent property taxes.
What are reasonable assumptions for insurance?
For property insurance, you should call your insurance agent and get a rough quote. I recommend you find a property that looks interesting that is typical for what you might buy… similar price, square footage, beds/baths and get a quote on that property.
Then ask your insurance agent if this is about what insurance might be on similar properties. We ask this because the property may have something exceptional that gives it higher or lower insurance and you'd want to seek clarification from your insurance agent on that before using it as a guide for other properties.
Then, once I have an insurance quote, I'd figure out what percentage of price the insurance is and use that as a rough rule for estimating insurance. For example, if you were given a quote of $1,000 per year for insurance on a property that is selling for $100,000 that means that insurance is about 1% of price. To estimate insurance in the future, I might actually code into the Excel spreadsheet that insurance would be equal to .01 of purchase price.
In our local market, I typically use a rough insurance number of .005 of purchase (or half a percent).
What are reasonable assumptions for homeowner's association (HOA)?
For HOA, I'd use what the MLS listing shows for HOA fees. I'd verify this information during the due diligence period once under contract.
Why do you say that lowering your Total Amount Invested magnifies your cash on cash return instead of improves it?
You may notice me say, from time to time, that lowering your Total Amount Invested magnifies your cash on cash return. Why not just say it makes it bigger? The reason I don't automatically say it makes it bigger is because if you have negative cash flow, a smaller Total Amount Invested actually makes it more negative.
Why can't I compare my Cash on Cash Return on Investment to returns that other investors I talk to tell me?
So you're at a local Nomad Investor Club meeting and talking to a new investor to the club. He's telling you that he is earning a 10% cash on cash return. You're upset by this since you're only earning a 5% cash on cash return. Should you really be upset?
Beyond the philosophical answer of no, there is a very practical reason that you should not be upset: not everyone calculates cash on cash return the same way.
In fact, since there are so many factors that can differ from person to person it is almost impossible to compare your cash on cash return to the cash on cash return that someone else is calculating. Here are a couple of examples of how using different assumptions could result in different cash on cash returns.
You have a $500 deductible insurance policy and your friend has a $5,000 deductible insurance policy. Your insurance is more than twice as much. So, your cash on cash return is much worse but if there was a claim, you'd have to come out of pocket only $500 where your friend would come out of pocket 10 times as much!
You're getting below market rent and your friend has the property offered on a lease option to a tenant buyer and getting a premium because they did not have a large upfront option fee.
You have a nothing down VA loan and your friend put 25% down.
You have amazing credit and your friend has bad credit with a much higher interest rate.
Your friend is managing their property themselves and you're having your managed by a professional.
Your friend calculates their cash flow without maintenance reserve or vacancy. You, correctly, include those.
As you can see there are lots of reasons why comparing cash on cash return could be very, very different.
Does Cash on Cash Return on Investment take into account depreciation?
Most of the time when we talk about pure cash on cash return, we are not including any depreciation benefit with it.
However, often when I teach classes and even on the spreadsheet we provide, we do have a section that calculates cash on cash return including depreciation.