Cash on Cash Return vs. ROI

Understanding Cash on Cash Return vs. ROI in Real Estate

Example Scenario:

You purchase a rental property for $200,000. You make a down payment of $50,000 and finance the remaining $150,000 with a mortgage.

Here are the key financial details for the first year:

Annual Rental Income: $24,000
Annual Operating Expenses (including property management, maintenance, taxes, insurance): $10,000
Annual Mortgage Payments (interest and principal): $9,000

Cash on Cash Return Calculation:

1. Calculate Annual Pre-Tax Cash Flow:

Annual Rental Income: $24,000
Annual Operating Expenses: $10,000
Annual Mortgage Payments: $9,000

Annual Pre-Tax Cash Flow = Annual Rental Income - Annual Operating Expenses - Annual Mortgage Payments
Annual Pre-Tax Cash Flow = $24,000 - $10,000 - $9,000 = $5,000

2. Calculate Total Cash Invested:

Down Payment: $50,000

Total Cash Invested = Down Payment
Total Cash Invested = $50,000

3. Calculate Cash on Cash Return:

Cash on Cash Return = (Annual Pre-Tax Cash Flow) / (Total Cash Invested)
Cash on Cash Return = $5,000 / $50,000 = 0.10 or 10%

ROI Calculation:

1. Calculate Total Gain from Investment:

Let's assume the property appreciates by 5% in the first year, adding to the capital gain.
Property Appreciation: $200,000 * 0.05 = $10,000
Total Gain: Annual Pre-Tax Cash Flow + Property Appreciation

Total Gain from Investment = $5,000 + $10,000 = $15,000

2. Calculate Cost of Investment:

Initial Purchase Price: $200,000

Cost of Investment = Purchase Price
Cost of Investment = $200,000

3. Calculate ROI:

ROI = (Total Gain from Investment - Cost of Investment) / (Cost of Investment)
ROI = ($15,000 - $200,000) / $200,000 = -0.925 or -92.5%

Clearly, the ROI calculation seems unrealistic due to a huge negative return, which typically wouldn’t include the entire property purchase price in this manner. A more realistic ROI formula often considered includes the net gain relative to the cash invested, for example:

ROI (Adjusted) = (Total Gain from Investment) / (Total Cash Invested)
ROI (Adjusted) = $15,000 / $50,000 = 0.30 or 30%

Summary of Differences:

Cash on Cash Return (CoC Return):

Focuses on the annual cash flow relative to the cash invested.
Simpler and immediate snapshot of cash performance.
Calculation: (Annual Pre-Tax Cash Flow) / (Total Cash Invested).

Return on Investment (ROI):

Considers the total gain, including appreciation, over the cost or cash invested.
Broader view of overall profitability.
Calculation: (Total Gain from Investment - Cost of Investment) / (Cost of Investment) or adjusted for more relevant context.

Understanding both metrics provides a comprehensive view of your real estate investment performance, helping you make more informed financial decisions.

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Cash on Cash Return vs ROI Calculation