Cash on cash returns assess the return on investment on the basis of the amount of cash invested to purchase the property.
FORMULA: Cash on cash ROI = pretax cash flow/cash investment
Pretax cash flow in real estate can be based on Net Operating Income (NOI) minus the mortgage payment.
The cash invested is the amount of cash invested to purchase the property (not including the amount financed).
Price of Property $1,000,000
Cash Investment $200,000
Annual Net Operating Income (NOI) = $135,000
[NOI = EBIT = Property's Income before Interest and Tax]
Annual Mortgage Payment (Principal and Interest) $40,000
[# depending on duration, monthly payments and interest rates]
Pretax Cash Flow = $135,000 - $40,000 = $95,000
Cash on Cash Return on Investment (ROI) = $95,000/$200,000 = 47.5%.
2. TOTAL RETURN ON PROPERTY INVESTMENT
Total Return on Investment
= (Pretax cash flow + Sales Proceed - Initial Cash Investment)/Initial Cash Investment
3 years after the above property was bought:
It is sold for $1,200,000.
Mortgage balance $762,000
Selling expenses including taxes and broker fees = 8% of sales price or $96,000
Net Sales Proceeds
= Sales Price - Mortgage Balance - Selling Expenses
= $1,200,000 - $762,000 - $96,000
Pretax cash flow per year = $95,000
Total pretax cash flow for 3 years = $95,000 x 3 = $285,000
Total ROI (over 3 years)
= (Pretax Cash Flow + Sales Proceeds - Initial Investment)/Initial Investment
= ($285,000 + $342,000 - $200,000) / $200,000
= $427,000 / $ 200,000
Several aspects of this deal proved favourable.
1. The appreciation over 3 years was substantial
2. The NOI was relatively stable
3. The cost of financing was low.
This proved to be a lucrative deal and the type that most real estate investors dream of.
The reality, however, is that any number of factors can hurt the Total ROI.
Price of Property $400,000
Cash Paid $100,000
Rental received $2,000 per month.
Annual net operating income = 10 months of rental.
Annual net operating Income (Property Income before interest and Tax) = $20,000 per year.
Mortgage Paid = $1,800 per month or $21,600 per year.
Pretax cash flow = $20,000 - $21,600 = - $1,600 per year
Cash on cash return per year = -$1,600/$100,000 = - 1.6%
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