How to calculate cash on cash
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Introduction:
When it comes to real estate investments, one of the most important metrics to consider is the cash on cash return. This ratio is used by investors to measure the profitability of a real estate investment by comparing the net cash flow generated by a property to the amount of money invested. Understanding how to calculate cash on cash returns can help you make informed investment decisions and ensure maximum profitability for your real estate investments. In this article, we will guide you through the process of calculating cash on cash returns.
Step 1: Determine Your Investment’s Net Operating Income (NOI)
The first step in calculating cash on cash return is determining your investment’s Net Operating Income (NOI). The NOI is your property’s total income minus expenses (excluding mortgage payments). To calculate NOI, follow these steps:
1. Add up all monthly rental income generated by your property.
2. Subtract any vacancies or non-payment losses from your rental income.
3. Subtract all operating expenses such as taxes, insurance, management fees, and maintenance costs.
Your NOI should represent a monthly figure that reflects how much money your property generates after accounting for expenses.
Step 2: Determine Your Investment’s Annual Cash Flow
Once you have calculated your property’s NOI, you need to determine its annual cash flow. This figure represents the amount of money left over after considering mortgage payments on an annual basis. To calculate your annual cash flow:
1. Multiply your NOI by 12 months to obtain the annual gross income.
2. Subtract your annual mortgage payment from your annual gross income.
The result should be a positive or negative figure which represents your net annual cash flow from the investment.
Step 3: Calculate Your Cash Invested
Cash invested refers to the amount of money you put into the property, including down payment and closing costs. This value will likely include:
1. Down payment on the property (purchase price multiplied by a percentage required upfront)
2. Closing costs such as title fees, escrow fees, and mortgage broker fees
3. Any additional funds needed for repairs or renovation
Add these amounts together to determine your total cash invested in the property.
Step 4: Calculate Your Cash on Cash Return
Finally, it’s time to calculate your cash on cash return. This can be done by dividing your annual cash flow by your total cash invested:
Cash on Cash Return = (Annual Cash Flow / Total Cash Invested) x 100
This formula results in a percentage, which represents the return on investment (ROI) specifically associated with the cash you have put into the property.
Conclusion:
Calculating cash on cash returns is an essential skill for any real estate investor, as it provides insight into an investment’s profitability and helps to inform decision-making. By following these steps and understanding how to apply them to various investment scenarios, you can set yourself up for success in the competitive world of real estate investing.