What is a Cash on Cash Return?

In addition to the cap rate, there is one more number that gets used quite a bit to determine the income potential of a property.  The calculation is known as the Cash on Cash Return.

Cash on Cash Return measures the cash left after all expenses, including the mortgage, but not including income tax (this is what many call ‘Positive Cash Flow‘ or ‘Net Pre-Tax Return on Investment‘) and compares the amount to the money at work in the investment.

So:  Amount of Positive Cash Flow (Pre-Tax Profit, AFTER Paying the Mortgage) divided by the total amount of cash invested to control the property equals the Cash on Cash Return.

Commercial Real Estate Vs. Residential Real Estate

Commercial Real Estate in Raleigh NC, for all but the owner-occupant, is solely an investment and the numbers need to make sense.

Unlike residential real estate markets, which are largely driven by whether or not people like or dislike a home, commercial real estate markets are driven by the profit that can be earned by owning the property.  For this reason, being able to understand the profit potential of commercial property is critical to success.

There are essentially three things that determine the quality of a potential investment:

  • The amount of appreciation expected in the property:  Just like any investment, people who buy commercial property are hoping for the value to increase over time.  Part of what a potential investor will analyze is the amount of appreciation compared to the amount of cash they have to invest to own a property.  This is known as leveraged appreciation.
  • The current, future and/or potential earnings of the property:  Income minus expenses should deliver a net profit.  Investors want to know how much money the property is earning or will earn.  They want to compare this to the value of the property, a comparison that is known as the Capitalization Rate, or Cap Rate.  They also want to compare this to the amount of money they have to invest to own the property.  This is known as the Cash-on-Cash Return.
  • The tax ramifications of owning the property.