What it means
The measure divides the pre-tax cash flow an asset produces in a year by the total cash the investor injected to acquire it. That cash figure includes the deposit, legal fees, transfer taxes and any refurbishment paid for before the asset started earning.
Borrowed money is excluded from the denominator, which is the whole point of the measure. It matters because a return calculated on total cost tells you about the asset, while cash on cash return tells you about your position in it.
Two investors buying identical buildings can earn very different cash on cash returns depending on how much they borrowed and at what rate. That makes it the right measure for comparing deal structures rather than assets.
Investors normally calculate it for the first full year after purchase and again as a forward-looking figure once rents or prices have been reviewed. Net operating income comes first, meaning rental or trading income less operating costs but before financing, and annual debt service is then deducted to reach pre-tax cash flow.
Dividing that by cash invested gives the percentage. The measure has real blind spots.
It ignores capital appreciation, loan principal being repaid, tax effects and the timing of cash flows, so it is no substitute for an internal rate of return on a multi-year hold. It is a snapshot of annual cash yield, nothing more.
Because it excludes borrowing from the denominator, more debt usually flatters the number, right up until it does not. A deal showing an attractive cash on cash return on 85% borrowing can turn negative after a modest rise in interest rates or a single empty quarter.
In practice
Real-world examples.
Example
An investor comparing two rental flats finds both yield 6% on price, but one can be bought with a 60% mortgage at 5% and the other only with 50% at 6.5%. The cash on cash returns work out at 7.5% and 5.5%, so the financing terms rather than the properties decide which deal proceeds.
Example
A buyer acquiring a coin laundry for $400,000 puts in $160,000 of cash and finances the rest. After $92,000 of net operating income and $34,000 of debt service, the $58,000 of annual cash flow gives a cash on cash return of 36%, which reflects both strong trading and a high level of borrowing.
Example
A haulage operator funding four trucks with a $50,000 deposit and $250,000 of asset finance measures the incremental cash the trucks generate after repayments. The 22% cash on cash return justifies the purchase, but the operator also models what happens if utilisation drops below 70%.
Think of it
“Cash on cash return is your cash yield-cash received relative to cash you put in.
Formula
Calculation
Cash on Cash Return = (Annual Pre-Tax Cash Flow / Total Cash Invested) x 100
An investor buys a small commercial unit for $1,000,000 with a 70% mortgage, so borrows $700,000 and puts down $300,000. Legal fees and a fit-out add a further $50,000, all paid in cash.
Total cash invested = $300,000 + $50,000 = $350,000
Net operating income = $75,000
Annual debt service (interest and fees) = $48,000
Annual pre-tax cash flow = $75,000 - $48,000 = $27,000
Cash on cash return = ($27,000 / $350,000) x 100 = 7.7%
For comparison, the unlevered yield on the $1,000,000 purchase price is $75,000 / $1,000,000 = 7.5%, so the borrowing has improved the cash return slightly. If rates rose enough to push debt service to $60,000, cash flow would fall to $15,000 and the cash on cash return to 4.3%.Case study
Seen in the real world.
Harlow Row Property Partners is an illustrative property partnership invented for this entry. It bought a small parade of shops for $1,000,000, funding it with a $700,000 mortgage, a $300,000 deposit and $50,000 of legal and refurbishment costs.
In its first full year the parade produced $75,000 of net operating income and cost $48,000 in debt service, leaving $27,000 of pre-tax cash flow and a cash on cash return of 7.7% on the $350,000 invested. The partners were pleased, and one suggested refinancing to 85% borrowing to buy a second parade on the same basis.
In this fictional example the finance partner modelled the downside first. At the higher borrowing level, a two percentage point rate rise combined with one vacant unit turned annual cash flow negative, so the group settled on 75% borrowing instead and accepted a lower headline return in exchange for surviving a bad year.
Watch out
Common mistakes.
- Using the purchase price rather than the cash actually invested, which understates the return on a leveraged deal.
- Forgetting to include acquisition costs and pre-letting refurbishment in the cash invested figure.
- Treating a high cash on cash return as proof of a good deal when it mainly reflects a large loan and the risk that comes with it.
Questions
People also ask.
Is cash on cash return the same as return on investment?
No; return on investment usually includes capital gains across the whole holding period, while cash on cash return looks only at annual cash income against cash invested.
Should mortgage principal repayments be deducted?
Yes, the full debt service including principal comes out, because it is cash leaving your account even though part of it builds equity.
Does it work outside property?
Yes, any deal with a cash deposit and borrowing works the same way, including buying an operating business, a vehicle fleet or equipment funded by a loan.
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