Realistically speaking, investing in a real estate property comes with plenty of risks. Just acquiring shares in a business, this type of investment isn’t really a sure thing. However, with proper research and analysis of data that can affect a home’s valuation, you can help minimize the risks and maximize revenues.
Luckily, for property investors like you, there are certain formulas that can help determine if your real estate investments will be profitable. These can include the cash-on-cash return. Keep reading this article to learn about what cash-on-cash return is and how it can help you as an investor.
What Is Cash-On-Cash Return?
In its simplest terms, cash-on-cash return refers to a rate of return being used to compute the total cash earned on the cash invested in a certain real estate property. It’s a metric usually being used to measure and determine the performance of a commercial real estate investment.
Also, cash-on-cash return is beneficial to business owners and real estate investors as it provides them with an accurate analysis of the investment plan for a property. In other words, this formula has been used in most investment analysis when exploring the possibility of investing in new properties.
Moreover, if you want to know how to calculate cash-on-cash return, the formula is very simple. All you need to do is divide the net cash flow by the total cash invested, and the result will be the cash-on-cash return ratio. Generally, the net cash flow refers to all cash in hand after the expenses have been accounted. This includes the monthly rent, less the utilities, pest control costs, trash collection, and many more. On the other hand, the total cash invested refers to all the capital allotted and placed in a certain property purchase. This can include the invested equity, upfront repairs, closing expenses, and other loan costs.
Once you have these two figures, you’ll be able to know and decide how much money you should invest in a particular property, or whether you should purchase the property from the start. However, if you want to do an accurate calculation of this ratio, consider using a cash-on-cash return calculator today.
Why Is Cash-on-Cash Return Important?
Now that you know what cash-on-cash return is and how it should be calculated, the next step is to get familiar with the reasons why this rate of return is important. Typically, most real estate property investors utilize the cash-on-cash return formula as one of the effective ways to make a sound purchase decision. That’s because it can provide several answers to key questions about how you’re going to proceed with a sale.
Here are a few reasons why cash-on-cash return is essential:
- Listing Down Of Potential Expenses – Before investing in a real estate property, the cash-on-cash return formula allows you to plan and prepare ahead for the possible expenses that are usually associated with rental homes. Remember, having a clear picture of what your potential expenses will be when investing in a property can help you determine whether or not your investment can provide you with better returns.
- Choosing The Right Property – As mentioned, the cash-on-cash return formula allows you to measure and figure out the long-term profitability of many rental homes. When you know how profitable the property will be in the coming years, you’ll be able to compare and pick the one that comes with the highest potential return on investment. This can be an efficient screening tool to ensure you’re making the right decision for your real estate investments.
- Determining Financing Options – When you have questions involving the property’s profitability related to financing options, using the cash-on-cash return formula can be one of the best ways to get answers. For example, whether you’re planning to take out a mortgage or make an all-cash purchase, the result of the calculation can help you figure out the wiser move to make.
With the information mentioned above, it’s not surprising why cash-on-cash return has been considered one of the most effective property valuation tools you can use for your research. And, while this formula definitely has weaknesses, it can be an excellent metric for investors who are planning to invest in a real estate property.
Remember, by using it along with other metrics and tools, you’ll get plenty of information, which is necessary to place the safest and most educated offer on a property. As such, this is the start of getting more profits, as well as growing your investment portfolio in the long run.