Cash on Cash Return: What It Is and Why It Can Be Deceptive

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You have money to invest or have leveraged money to purchase a cash flow multifamily property.  One of your concerns for the investment is the rate of return you could receive from the property.  Will the rate of return on your equity in the property be equal to or hopefully better than some other investment, like stocks or a US Treasury Bond?  An investment measure that could answer that question is the Cash on Cash Return or CCR.

A lot of emphasis has been placed upon the CCR by investors, accountants and other real estate professionals.  It has been said that when analyzing the long-term performance of a property’s investment, the CCR is most important.  This may or may not be true.

My first reaction, to any statement that points to one ratio or metric as the most important, is suspicion.   Really, is one ratio all you need to make an investment decision?  I can hear the experienced investors here at BiggerPockets shouting a very loud NO!  Making decisions with large amounts of investment dollars cannot be reduced to one quickly calculated ratio.  If it were that easy the number of discussions, here at BiggerPockets, on evaluating a property would be greatly reduced.

Real estate investing and property analysis requires more than just one ratio.  Analysis requires working with “the numbers”; making educated assumptions and then arriving at plausible decisions.  In order to do the analysis, we must fully understand the features or values that make up the ratios or metrics within the analysis.  It is time to shine the light upon the Cash on Cash Return ratio.

What is the Cash on Cash Return

The Cash on Cash Return is a ratio based on the annual cash flow divided by the equity you have invested into the property, the formula is;

= Cash Flow / Invested Equity.

You will usually see the CCR in a cash flow analysis worksheet, after the Before Tax Cash Flow calculations.

Cash on Cash Return in a 10 year Proforma

The equation is a simple arithmetic problem that could be done in your head or with a calculator.  If you are using a worksheet for a cash flow analysis, the CCR is one of the easiest formulas to enter.

Apply the CCR equation to a fictional apartment building with an annual cash flow of $100,000, where you invested $1,000,000.  You probably have the answer already;

100,000 / 1,000,000 = 10.00%

A 10% return on your investment dollars of $1,000,000.  All you need now is to find an apartment building with a $100,000 annual cash flow, easy, clean and quick.  Buying an apartment building is so easy anyone, even with no money to invest can do it.  I hope you realize the previous sentence was taking a jab at the late night infomercial real estate gurus.

Cash on Cash as a Comparison

Let’s go back to the example of the 10% return on the apartment building.  With that 10%, you can compare the return against other investments in order to help you decide whether the multifamily property is worth your investment dollars.  With the 10% CCR, what would the return be on a CD, stocks, bonds or other investments?  How does the multifamily compare to the other investments?

In the above example, a 10% return, on the surface seems to be a good investment. What factors can influence the calculation of the Cash on Cash Return?  Understanding the factors involved with the annual cash flow and the initial equity could affect our assumption of the CCR’s value.

Factors that can Influence the Cash on Cash Return

A property has large annual cash flows over an extended period of time.  Large cash flows could also mean high cash on cash returns.  If you were in the market for this property, the returns over the years would lead you to think that this would be a good investment.  Before jumping to this conclusion, you should ask why the property has such large annual cash flows.  What if, the property has a number of deferred maintenance issues?  How old is the roof, when were the last repairs done to the heating and cooling systems, how old are the electrical and plumbing systems and the presence of a security system if needed?

Properties with deferred maintenance issues will naturally have a higher cash flow.  Money is not going to the correction or maintenance of the property. But if you purchase that property based just on those high cash on cash returns, guess who will be stuck with the delayed repairs?  Not understanding the calculations or factors that affect the calculation of investment metrics can easily cost you in the end.

Here is another scenario.  You are interested in another multifamily property and your agent has obtained the first year of operations from the owner’s Proforma.  Using this data you have made some projections for the future years based on your assumptions for the property.  How sure are you of your assumptions?  What would happen if they were wildly incorrect?  How would that affect the cash on cash return?

Future Predictions

No one can predict the future. No one can be 100% accurate on any assumptions made in real estate investing.  However, we all must make assumptions based on prior historical data and experiences.  You must be very careful if you will base your purchasing decision on the Cash on Cash Return 5, 10 or 20 years into the future.

Twenty years from now, how can you compare a CCR to a US Treasury Bill?  Cash on Cash Return is most effective in the first year of operation for a property.  In the first year you accurately evaluate the income that the property has produced.  After the first year, assumptions have to be made about future income.  Realize that the CCR does not account for the time value of money principle.  A dollar today is more valuable than that dollar in the future.  Consider that the Cash on Cash Return will only be as strong as your assumptions.

The Cash on Cash Return could be valuable when comparing other investment options.  You have to remember the factors that could affect the calculation of the ratio.  Used with other investment measures and ratios, the CCR is another return that could assist you in your investment decision process.

Photo: Andy

About Author

Loretta Steele is a computer instructor at Moreno Valley College and a real estate broker. She focuses on investment analysis of multifamily properties using Microsoft Excel. She has instructed others in computer applications for over 10 years. Loretta is also the creator of three real estate investment software products; APOD Extra, InvestorApt Analysis and AgentApt Analysis.

25 Comments

  1. Brandon Turner

    Awesome post Loretta! Really, I love when people break down confusing topics in an easy to understand format like this. In addition to helping those who read it this week, I bet Google will like this article too and send people here for years to come when people search for info on “Cash on Cash Return.” Awesome!

  2. @Loretta Steele Excellent post. I have been very vocal here about the over-emphasis on CCR as a key (often a sole) metric, citing some of the very same warnings you bring out. Perhaps key among them is that it looks at a property’s performance at a point in time; as such it can provide useful information about current performance, but is largely meaningless as a measure of future perfomance for precisely the reason you cite: it ignores the time value of money. How can one index a cash flow that might occur well into the future against n cash investment that occurs in the present?

    For me, at least, your post is especially timely. I spent six and a half hours yesterday lecturing my grad students at Columbia on the basics of real estate investment finance (my tonsils have not yet recovered). Part of that lecture cited the very caveats you raise here about cash-on-cash return, and about over-reliance on metrics that fail to take into account the long-term performance of a property.

    Thanks for a valuable post.

    • Adam Demchik on

      @Loretta Steele @Frank Gallinelli…great point. I have a few other metrics I look at such as cash/door/month, CAP rate, and total return. Are there any others I should be considering? I am actually in the middle of a deal on a property with numerous deferred maintenance issues. In addition its on a septic field and now that the city has run sewers past the property I am guessing that in the coming years I will need to pay to hook into the sewer system.

  3. Great post Loretta!

    Cash on Cash Return is our number 1 first level hurdle, not out into the future, but right now today. If the deal doesn’t cash flow adequately day one using our conservative underwriting it’s not an investment, it’s a speculation and a speculation is just a half step from a gamble.

    We also look at DCF, NPV, IRR and MIRR but they all share the same flaw; they depend on human forecasting of future economic trends…. and we know how dependable they are (Of course our own crystal balls are perfectly clear- NOT). A cursory read of the available literature and research on our cognitive biases clearly shows what we’re battling against when we try to peer into the future.

    To combat them we try to model a real estate cycle with rising and falling interest rates, cap rates and rates of return. We start with our estimation of where a particular property is in its cycle but the bottom line is we’re just estimating. What effect is ZIRP and QE Infinity going to have? What if we are really in the 30’s like depression that Bernanke is fighting so hard to keep us out of? What if Europe finally wakes up and smells the coffee? What if the Chinese can’t really dictate the 7-8% GDP growth they need? What if Japan really is that bug in search of a windshield? Who really knows?

    That’s why I think the initial Cash on Cash Return is so important. If it doesn’t work out of the box what chance does it have 5, 10, 15 years from now? The only thing we can know for sure is whether it works today. Looking out into the future we can go by cycles, trends, past history but it’s just a guess. I would say if it doesn’t work today it doesn’t stand much of a chance working in the future. If it does work today then it has a shot working in the future and that is all we can reliably expect given out limited ability to see the future.

    • @Giovanni Isaksen You’ve made an eloquent defense of CCR, and I can agree with much of it, but not quite all.

      To be sure, a property that currently throws off a weak cash flow is not likely to be your prime candidate for investment of the year; and, indeed, projections as to future performance generally require a good deal of speculation. However, there are situations where future considerations may be known in advance, and where they can significantly impact one’s evaluation of the long-term performance of a property.

      For example: You are analyzing a retail property, with strong tenants that have built-in escalations that will kick in at defined intervals in future years. You still have to speculate on the growth of expenses (unless the property is NNN) but you can reasonably anticipate revenue changes — perhaps significant changes — that are within your long-term horizon. Similarly, you may look at a property — perhaps office or retail — that is humming along with a good cash flow currently, but key tenants are approaching the expirations of their leases and you have doubts about the likelihood of renewal. Current CCR looks great, long-term prospects look dicey, especially if the turnover period is protracted.

      Perhaps you’re considering another property, again with a good CCR, but careful examination shows the need for capital improvements, such as a new roof, within five years. How will you factor that into your CCR? Place the cost all into funded reserves now and add it your cash invested? Place one fifth now, assuming that you’ll do the same for each of the next few years? Ignore it entirely? It would seem that these different choices could result in skewed CCRs.

      I certainly don’t quarrel with giving a hard look at a property’s current-year performance; in fact I think that is essential. But I also believe it’s just as important to make not just one but a series of pro forma projections as to how the property might perform over time. What will be the impact of scheduled rent changes or major turnover, such as I described above? What if cap rates rise, or what if they fall? Is there a range of possible outcomes within which you can find this deal acceptable?

      Since CCR is insensitive to the time value of money, I don’t feel it has a place in a multi-year analysis. DCF / IRR / MIRR are my choices there.

      I’ve seen examples where a current-year metric such as CCR or cap rate might lead an investor to one opinion of a investment, while a longer view might give an entirely different take on it. My approach would be not to rely on just one approach or metric.

      • Thanks for you detailed reply Frank. You are absolutely right that when future income increases or expenses are ‘baked in’ then you can have situations where things will improve (or go downhill) with a good amount of certainty. In the case of looming expenses the way we try to incorporate those into our model is by funding them up front or funding a reserve for them as you suggest.

        When we look at our potential cash on cash return for a subject property we the income and expenses we expect and include funding the reserve as part of those expenses if multiyear or as part of the acquisition costs if they will be funded up front. Granted that CapEx reserves are not expenses from an accounting standpoint but our approach is that money is going to come out of cash flow as some point and we would rather take it in smaller doses than having to scrape the funds together at the last minute.

        To be perfectly clear Cash on Cash Return is just the first level hurdle we have for a property and they also have to pass DCF/IRR/MIRR hurdles as well.

        BTW I was rereading your 10 Commandments For Real Estate Investors last night, word for word the most valuable book on real estate ever written!

        • @Giovanni Isaksen Thanks for your comments, Giovanni. Wish I had thought of the expression “baked in” — captures it perfectly.

          And I appreciate your comments on funded reserves as well. In our company’s software we typically treat first-year capex costs as part of the inital uses of funds, so essentially they’re getting partially baked into the initial cash invested.

          Thank you so much for the kind words on my little op-ed book! Your praise is too extravagent — but the less it is deserved, the more it is appreciated. 😉

    • Great question Tracy!

      To answer that we look at the difference between the Cap Rate and the Cash on Cash Return. If the CCR is higher than the Cap Rate we consider the deal to be positively leveraged and a plus, otherwise with negative leverage we need to see a lot of upside within the first year or two to be worth an offer.

      • Paula Pant

        I had the same question as Tracy — my “problem” with CCR is that many people use it to justify wild levels of leverage. If you (hypothetically) put down $1 and borrowed the rest, your CCR would look excellent, regardless of whether the deal is good or not. That’s why CCR shouldn’t be the only metric used, especially when leverage is involved.

        I like your answer (about comparing CCR to Cap Rate). I’ve always been a big fan of examining Cap Rate when evaluating a rental property.

        • Leveraged money that is used to acquire a property must be accounted for in any calculation involving a rate of return. I am a big opponent to the “one metric” concept of property analysis. Just as you stated; “CCR shouldn’t be the only metric used, especially when leverage is involved”.

          Paula, thanks for commenting on the post.
          Really like the philosophy of your website; “You can’t afford everything. But you can afford anything”

        • When looking at the potential leverage in a deal we (and our lenders) look at a number of other factors including Loan To Value (LTV), Debt Coverage Ratio (DCR), Debt Yield and Break Even Ratio (BER), which Frank covers in his What Every Investor Needs to Know About Cash Flow.

          I particularly like BER because it represents one of the ‘Margins of Safety’ that we as value investors are looking for. If you Google ‘Margin of Safety’ you will get about 22 million hits and if someone is not familiar with the concept I highly recommend reading up on it.

  4. Frank, Adam, Giovanni and Tracy, thanks for the informative and positive comments on this post.

    Evaluating a property involves an examination of its potential cash flow, leverage and market conditions, and their relations. Hence the word “analysis” in property analysis. Focusing upon one metric over another breaks this relationship. I think in the end, we would all agree that property analysis is not static, but an oncoming process that must be reviewed and re-analyzed as these relationships change.

    Again, thanks for reading and commenting on the post.

    • Excellent post Loretta!

      Every point you make is right on. The application of the thought process that you’ve described is the gold-standard. Few people have the intellectual control of the subject-matter to be able to break it down in a way that youngens like Brandon Turner can understand LOL

      Though I concur with all of your logic, I am not sure that I agree with your main premise and/or conclusion. Though it should never be the only one, in my opinion COC is indeed the most definitive element in any deal, but this is all in how you look at it. Perhaps this would be a good post 🙂

  5. Thanks Loretta for a great article. Can you or someone please further elaborate
    “Realize that the CCR does not account for the time value of money principle?”
    I am still trying to understand that concept against CCR and do not fully understand the relationship. I read the comments above about time value of money but am not comprehending the relationship????

    Thanks!

    • David, thanks for your comments.

      A dollar today is more valuable than that dollar in the future, that is the concept of “the time value of money”. You can take today’s dollars and invest them versus waiting to receive the dollars in the future. The investment dollars in the future could be affected by changes in the market, a change in your investment strategy or other factors. Therefore, to valuate future dollars, they need to be discounted to reflect present values.

      The CCR is looking at annual cash flows and the equity invested. The cash flows 5 or 10 years into the future are not discounted to present values. The time value of money principle is not applied in the CCR calculation.

      I have a previous blog post that presents the concepts of future and present values at: https://www.biggerpockets.com/renewsblog/2013/05/29/calculating-present-value-excel/. You can also find it in my archives titled: “Calculating Present Value with Ease Using Excel”.

  6. Thanks Loretta. I think I get it now and like Giovanni’s reply above that if CoC doesn’t cash flow out of the box, what chance does it have 5 or 10 years from now. Thanks for a great article.

    Finally, would you say the biggest threat to CoC since it doesn’t count time value of money is either inflation or miscalculation of of an investors’ expenses?

    • David, inflation and miscalculation of an investor’s expenses are a big factor affecting CoC.

      In all my articles, here at BP and on my website, the main point I try to make is to understand how the different investment metrics are calculated and how their results can be affected. Also understand that there is no one metric that will give you the answer to all your investment decisions. As Frank, Giovanni and others have stated, their are a number of metrics to consider at various times and for various reasons.

      Thanks again for your comments and questions.

  7. Not the sharpest knife in the drawer so bear with me here please.
    My gross rents are 10800.00, my expenses all in per year are 3200 =7600.00 ,I paid and rehabbed for a total cost of 50,000. My CRC is :15% correct? I did not add in depreciation but did factor in vacancy, taxes, insurance, maintenance.

    Thank you,
    Scott

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