Understanding Cash on Cash Return Is Your #1 Priority!

[Dan Gandee]

When I first got started in this business my mentor said "Start with the numbers and be an expert at spreadsheets!" Boy was he right...This game is more underwriting than anything. It doesn't matter how much money you have, how long you've been selling real estate, or what property management experience you have under your belt. When you know how to analyze properties then you can make smart decisions, limit risk, and create faster acceleration with your portfolio. I tell everyone I mentor the same. Don't start with cap rate, gross rent multiplier, 1% rule, or any other metric. Start with CoCr!

When it comes to investing in real estate, one of the most important metrics to consider is cash on cash return (CCR). This is a measure of the amount of cash generated by an investment property compared to the amount of cash invested. Understanding CCR can help investors make informed decisions about which properties to invest in and can help them maximize their returns.

Cash on cash return is calculated by dividing the net operating income (NOI) by the amount of cash invested in the property. The NOI is the income generated by the property, minus all of the operating expenses, such as property taxes, insurance, and maintenance. The cash invested in the property includes the down payment, closing costs, and any other costs associated with the purchase of the property.

For example, if an investor purchases a property for $200,000 with a down payment of $50,000 and generates $20,000 in net operating income per year, the CCR would be 40% ($20,000 / $50,000).

A high CCR indicates that an investment property is generating a significant amount of cash relative to the amount of cash invested. This can be a good indication that the property is a good investment, as it has the potential to generate significant returns. However, a high CCR alone does not necessarily indicate a good investment, as there are other factors to consider, such as location, market trends, and property condition.

CCR analysis is particularly useful for investors who are looking to purchase rental properties. Rental properties generate income through rent payments from tenants, and the CCR metric helps investors understand how much income they can expect to generate relative to the amount of cash invested in the property.

Another important factor to consider when analyzing CCR is financing. If an investor finances a property with a mortgage, the monthly mortgage payment will need to be deducted from the net operating income before calculating the CCR. This means that the CCR will be lower if the investor finances the property, but it may still be a good investment if the CCR is higher than the investor's required rate of return.

In addition to analyzing CCR, investors should also consider other metrics such as cash flow, capitalization rate, and internal rate of return when evaluating a potential investment property. These metrics can provide a more complete picture of the potential returns and risks associated with a particular property.

In conclusion, cash on cash return analysis is an important tool for real estate investors to evaluate the potential returns of investment properties. Understanding CCR can help investors make informed decisions about which properties to invest in and can help them maximize their returns. However, it is important to consider other factors in addition to CCR when evaluating a potential investment property. By analyzing multiple metrics, investors can make more informed and effective investment decisions.