There are many ways to analyze the performance of a real estate investment. Cap Rates, Gross Rent Multipliers, Cash on Cash and many other performance metrics can be used by investors to determine the specific performance and value of a real estate investment. Individually these performance measurments can help the investor isolate their investment goals, but collectively they can provide a macro view of the overall value of an investment.
In this post, we're going to look at one of my favorite performance measurements called cash-on-cash. Simply put this measure will look at how much cash came out of your pocket and how much cash goes into your pocket, hence the term cash on cash or cash-out vs cash-in.
Cash on Cash will provide you with a simple rate of return based on the total out of pocket investment that you have commited to the property. This will include the down payment, closing costs and any capital improvements you did on the property to ready it for rent. Once you know the total out of pocket expense for the property you can compare that to the returns generated by rent collection less expenses.
The formula for cash on cash is: Before-tax cash flow / Initial Investment = % rate of return
Cash on cash is good way to measure the rate of return generated by cash flow, to the rates of return of any alternative investments that an investor would consider. (meaning non-real estate investments)
- Pros: Cash on cash takes into consideration vacancy and uncollected rent, operating expenses, and debt service.
- Cons: Cash on Cash does not take into consideration anything past a first-year forecast. It does not take into account tax considerations or any increase or decrease inequity.
Knowing how to properly analyze investment properties is the first step to mitigating risks and maximizing profits. Learn to do this effectively, and you'll see how easy it is to identify the performers from the non-performers.
If you need professional advice on selecting and financing your next real estate investment, call Martin Rodriguez and get a free consultation.