The Ultimate Analysis: Cash on Cash Return vs. Overall Return

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There’s been quite a bit of interest and discussion in the BiggerPockets Forums about the differences between the cash on cash return and the overall return, which one is more important and what makes for a good return in the context of rental properties or apartment buildings.

Let’s discuss each in turn.

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What’s the Difference Between the Cash on Cash Return and the Average Annual Return?

Zillow ranked Oklahoma City as the Top Area Where Mom-and-Pop Landlords Make the Most Money.

Assuming you bought an average house for $120,000 in 2009, put 20% down and financed the rest at 4.5% over 30 years, Zillow says that the spread between the rental income and your mortgage payment is a gross profit of $536 per month. Deduct from that $100 of property taxes and $30 insurance, and you’re left with $406, which we’ll call our monthly cash flow. Note that for underwriting purposes, you should also include other expenses, like a home warranty, maintenance & repairs, leasing costs and a vacancy factor, but for the purposes of this exercise, we’ll leave those off.

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

In any event, our annual cash flow is $406 x 12 = $4,777. (BTW, you can follow along and check my math with the BiggerPockets Rental Property Calculator).

What was the cash you invested to close on the house? You had to put 20% down, pay 3% in closing costs, and you did $2,500 in light renovations to get the house rent ready. In all, you had to come up with $30,100 in cash to buy this house.

Your Cash on Cash Return (or COCR for short) is the annual cash flow divided by the cash you invested to buy the house. So: $4,777 / $30,100 = 16%

Let’s talk about the overall return. Let’s assume that you could resell the house in 2 years for $140,000 because you bought it right, and the property appreciated a little bit as well. When you sell you’ll have to pay 3% closing costs, 6% commissions, pay off the mortgage and deduct the cash you initially invested. After punching all of this into a spreadsheet, you’re left with a net profit of just under $2,849.

But in addition you had 2 years of cash flow totaling $4,777 x 2 = $9,614, and if you add that to the profit from the resale, your total profit is $12,463. The overall return is then your total profit ($12,463) divided by the cash you invested ($30,100) which is 41%. Since you held the property for two years, your average annual return is 41% divided by 2 which is 20.5%.

So you’re making about a 16% return on your money each year (the COCR), and your overall return after you sell the whole thing after two years is 21% per year.

Which is More Important: the Cash on Cash Return or the Average Annual Return?

It depends on what you’re looking for.

Related: Return on Investment (ROI) Versus Cash on Cash Return (CCR)

If you’re looking for income to replace your job, you’ll likely want monthly cash flow. You’re going to look for a high cash on cash return, and you may OK with the lack of any upside (as long as the property value isn’t going down!). It looks like you’re headed to Oklahoma City!

If you’re good on the income side, you may be happier with compounding your money by appreciation. This means you could buy in hotter areas, where the cash flow is minimal but the appreciation potential is enormous. Check out San Francisco! Or flip some houses!

The nice thing about commercial real estate in particular is that you can build value in ANY market, as long as you can increase the net operating income of the property. You could buy an apartment building at a fair market valuation on current financials and then increase the rents and decrease expenses. Doing so increases the value of the building, sometimes substantially.

What’s a “Good” Return?

This is a difficult question to answer because it depends on you, your investors and the kind of deals you’re doing.

For example, your friend and family investors may be happy with a 10% average annual return, but a more sophisticated investor may not consider anything below 20%. In this case, you may be looking for stable, high-yield commercial property for maximum cash flow, but with no or little upside. Or perhaps you’re a developer who will face 2 years of negative cash flow, but you’re projecting a much bigger upside.

Based on conversations with other apartment building investors and the BP Forums, it appears that a 10% cash on cash return for this asset class is something to strive for. If you can’t achieve that on day 1, then get there as soon as possible thereafter. Investors typically like an 8% preferred cash on cash return plus some upside equity.

A Healthy Mix of Cash Flow and Upside

On the single family houses, I always loved the lease option strategy. You buy a house under market (but not crazy under market), put a lease option buyer in there who pays you an upfront option fee and possibly a higher-than-market rent to get some rent credits, and then he buys it at a higher price than you bought it WITHOUT any broker commissions. What a fantastic model if you’re into single family houses!

On the apartment building side, I like the combination of some cash flow, adding value over 3-5 years and doing a cash-out refinance that returns part or all of the cash initially invested (taking the risk off the table and allowing you to reinvest the money) and then holding it indefinitely.

As Minh Le put it in a recent BP Forum post, “There is no right or wrong answer. Cash-flow gets you off the rat race while appreciation builds your wealth.” And Troy Fisher wrote “we all have different End Games, and you’ve got to plan and dream to your own.”

What kind of returns are you looking for? What are you actually getting?

Leave a comment below!

About Author

Michael Blank

Michael Blank’s passion is being an entrepreneur and helping others become (better) entrepreneurs. His focus is buying apartment buildings by raising money from private individuals. He’s been investing in residential and multifamily real estate since 2005. He is the creator of the Syndicated Deal Analyzer and the eBook "The Secret to Raising Money to Buy Your First Apartment Building".

15 Comments

  1. Great analysis, unfortunately, appreciation is a hocus-pocus number. No one knows what it will be, until after you sell. Buying for the sole purpose of appreciation is more like speculating. You are far better off in the stock market, or Vegas.

    But your method of selling a home, to a semi-qualified buyer with a higher than market rent/option, makes sense from a sellers point of view. You have locked in appreciation early in the process, assuming a appraisal comes back OK.

    I typically look for 15%+ cash on cash, and when I factor in my own management, it jumps well over 20%.

    • Michael Blank

      I agree WRT appreciation. In fact, with interest rates eventually going up, cap rates will go up as well, making property actually DE-preciate. So we have to be careful to consider that in our underwriting of deals.

      Eric, when you say you look for at least a 15% cash on cash return, what asset class are you seeing that in? (single family house flips, holds, lease options, apts, storage …)?

  2. Great article. I remain conflicted because what is better 10 properties with great COC and CF of 4k to 5K per month or 3 to 4 properties in a higher demand area with lower COC but with similar cash flows? Or am I simply comparing apples to oranges?

    • Michael Blank

      Eric, it depends on your situation: could you really use the income now? Then look for higher cash flow. If not, and as long as there is still positive cash flow to give you a margin for error, you could consider properties with lower cash flow. Still, you shouldn’t rely on market appreciation to get your return, you should have a solid business plan to increase net operating income (and therefore value) with whatever property you buy.

      • Michael Blank

        Sorry, one more thing to add WRT your question re: apples to oranges. The *true* metric to compare “apples to oranges” is the internal rate of return (or IRR). The IRR takes into account ALL variables of an investment that lets you compare different kinds of investments (even those with high cash flow vs. low cash flow but higher appreciation) in an “apples to apples” way. It takes as input initial cash investment, cash flow distributions, any additional cash investments (if any), proceeds from a cash-out refinance and proceeds from an ultimate sale. And finally, it incorporates time. There are several excellent articles to explain IRR on the Bigger Pockets blog, check ’em out …!

        • Thank you. My goal to date has been to get into high demand areas and cash flow with rents in the 20 to 30 percentile range and then raise them by 200$/ mo per year/ Q2 yrs. Thus my cash on cash starts in the 7 to 9 range and then trends upward. I tend to think more about increased cash flow over time.

  3. First of all, thank you for the informative article, the great analysis and the useful numbers. I am looking for a solid monthly cash flow and usually invest in properties that could make me no less that 15% cash on cash return. I really liked the idea for the healthy mix of cash flow and upside even though I don’t have such a deal in my career yet.

  4. had a quick read of your number projections. what are you projecting as net cash flow % before
    Mortgage PITI? In my experience anything under 50% is a big reach. The entire strategy depends upon that Net income before and after PITI, if you overstate that not much point in cash on cash or total cash calculating in my mind.

    • Michael Blank

      Hi Jeffrey … I typically underwrite deals using expenses of 50% of income for properties where the tenants pay for their own electric and gas, 55% if not. However, I’ve seen larger properties (75+) run at 60% because of the additional pay roll overhead required, so 55% may not be conservative enough …

  5. Frankie Woods on

    Great article as always Michael. I have been searching for 20% CoCR, but it has been very difficult. I have been able to get near the 15% mark though. It’s nice to see a range to shoot for. Thank you for the article!

  6. Jeff M.

    Hello. This is my first question as I joined BP today. I think I’ve got the concepts but not the terminology. Question: Why not use the amount of rent that goes to pay down principal as a factor in NOI or ROI? For example, on a $100,000 cash outlay I have $1,000 per month positive cash flow. This is $12,000 cash on cash or 12% right? But I also happen to have a 15 year low interest loan and pay $1,000 per month towards principle. By my way of thinking, this principle payment is the same “affect” as cash on my net worth and adds another 12% annual to my return. Am I missing something fundamental or is it just a matter of how we each want to look at it to meet our management style and goals? My goal is to own legacy properties outright so I have passive income when I am a geezer with a gold club. Thanks! Glad I found this community!

  7. Cody Steck

    I know that cash flow and equity as well as just about anything else can be negotiated in a partnership on a deal but what is an average breakdown for these things after you pay the cash investor his preferred return?

    For instance, I have a deal I am looking at that requires 30k down. I want a partner to put up the money for the down payment and take an 80% ownership while I take 20%. The property will cash flow $5,400/year, so his 8% preferred return works out to $2,400/year. What would be a typical or realistic split for the other $3,000 in yearly cash flow? Does he then get 80% due to his ownership stake while I take the remaining 20%?

    Any thoughts are greatly appreciated.

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