Cash on cash return (ConC) is a buzzword with many commercial real estate investors. Exactly what is cash on cash return and how should you calculate it?
Also known as cash yield, cash on cash return is a useful metric that compares the amount of net cash inflow from a property with the amount of cash invested in the property. In simplest terms, cash on cash return measures the amount of money you earn on the cash you invest.
The formula for cash-on-cash return is:
How should you calculate cash on cash return?
Calculating cash on cash return is straightforward, as long as you remember that:
- The calculation is based on pre-tax income.
- Cash inflows include regular rent payments as well as additional cash payments related to late fees, storage fees, special services that you charge for, and any other cash payments.
- Cash inflow is net of all the expenses related to earning it. From your commercial property’s income, you would subtract expenses for maintenance and repairs, utilities, cleaning, groundskeeping, parking, property taxes, insurance and so on.
- Total cash investment includes all the capital laid out for the property; this would include repair costs you incur before putting tenants onto the property.
- Costs associated with a loan taken on the property (payments and interest) are not included as cash investment.
An example will add clarity.
You are a commercial real estate investor interested in properties in or near Jackson, Mississippi. You locate a strip mall with 5 suites, 4 of which are currently leased. You have capital of $1,220,000 to put toward the purchase, and would finance the rest of the price. You estimate that your monthly loan payment would be $3,000.
You expect an annual cash inflow of $240,000 and related expenses of $60,000. The unoccupied unit would need approximately $30,000 of repairs before being leased. Factoring in the time it would take to make the repairs and find a tenant leads you to expect a 5% vacancy rate for the property as a whole.
What’s the estimated cash on cash return for this strip mall?
Calculate the NOI.
Reduce the $240,000 cash inflow by 5% to reflect the vacancy rate. Subtract the $60,000 of operating expenses and $36,000 of debt service from the adjusted cash inflow of $228,000.
Net operating income is $132,000.
Calculate the total cash investment.
Add the capital investment of $1220,000 and the $30,000 of initial repairs. Total cash investment is $1,250,000.
Divide NOI by the total cash investment.
This yields a cash on cash return of 10.56%
Is this a good cash on cash return?
Maybe. Generally, the rule of thumb for a good commercial cash on cash return ranges from 8% to 14%. Our example certainly falls in that range. However, several factors influence what an attractive rate is for a particular property. These include:
- Investor preference. Some investors wouldn’t consider anything less than 20% to be attractive. Others would be thrilled with 8%
- Market location. A cash on cash return can vary based on the market you are investing in. A 10.56% might be good in Jackson, MS, however, a 8.56% might be great in Dallas, TX.
- Type of commercial property. Average cash on cash returns differ among office, industrial, retail, and multi-family properties.
Cash on cash return is a popular metric among commercial real estate investors because it allows them to see what they earn on the cash they invest. It’s easy to understand and relatively straightforward to calculate. When used in tandem with IRR, CAP rate and other metrics, cash on cash return provides important information that helps real estate investors make decisions that meet their investment goals.
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