Investing in multifamily assets can be a profitable venture, but it’s important to have a strong understanding of financial metrics when evaluating a prospective investment. One key metric that can help investors evaluate a potential investment is cash-on-cash (CoC) return. In this article, we will discuss the basics of cash-on-cash return, its significance in multifamily property investing, and how to calculate and utilize it alongside other key metrics including cap rate and internal rate of return, or IRR.
What is Cash-on-Cash Return?
Also known as cash-on-cash yield, CoC return is a levered rate of return ratio used to assess the profitability of an investment. Specifically, it determines the annual, pre-tax cash flow generated by an asset relative to the amount of cash invested in the asset. The metric also considers financing structure and leverage and may be called the levered rate of return.
CoC return is useful for real estate investors because it provides an initial estimate of the return on invested capital over a period of time—typically one year. While it is primarily used for quantifying the profitability of an investment, the metric is also helpful in evaluating the impact of leverage and conducting comparative analyses.
How to Calculate Cash-on-Cash Return
CoC return is determined by two components: annual pre-tax cash flow and equity invested. The formula for calculating CoC return is expressed as a percentage:
Annual pre-tax cash flow: Scheduled gross income minus vacancy, operating expenses and annual debt service or mortgage payments
Invested equity (or cash): The sum invested at the date of acquisition or investment
Below is an example of CoC return.
Cash-on-Cash Return Versus Cap Rate
The capitalization rate, or cap rate, and CoC yield are both measures of return. However, the cap rate does not account for the impact of financing. Instead, it utilizes an unlevered measure of profit (net operating income) for the numerator. In addition, the denominator in a cap rate formula utilizes the fair market value of a property while the CoC return formula’s denominator is the equity invested.
Cash-on-Cash Return Versus IRR
An investment’s internal rate of return (IRR) and CoC return are both used to quantify an investment’s profitability. However, there are several key differences. The IRR takes the time value of money into consideration, while the CoC return does not. In addition, the CoC considers cash flow from a particular period of time, typically one year, while the IRR considers all cash flows during the lifetime of an investment, also known as its hold period.
The cash-on-cash return metric serves as a fundamental gauge of profitability and provides a crucial lens for examining investments within today’s dynamic capital markets environment. Its ability to identify the impact of leverage and estimate profitability makes it a valuable companion to other essential metrics like cap rate, IRR and discounted cash flow analysis, enhancing an investor’s toolkit for conducting comprehensive financial analysis.
