The Importance of Cash-on-Cash Return in Commercial Real Estate Investment

Ehsan Deihimi

| : 1801 | Published on: Thu 05 Jan 2023 (1 year, 8 months)

The Importance of Cash-on-Cash Return in Commercial Real Estate Investment

Cash-on-cash return, also known as cash yield, is a key metric used to evaluate the profitability of a commercial real estate investment. It measures the amount of cash flow generated by an investment relative to the amount of cash invested in the property. In other words, it shows the investor the percentage of their initial cash investment that is being returned as cash flow each year.

Calculating Cash-on-Cash Return

Calculating cash-on-cash return is relatively simple. The formula is:

Cash-on-cash return = (Annual cash flow / Initial cash investment) x 100%

For example, let's say an investor puts $100,000 cash down on a commercial property and the annual cash flow from that property is $10,000. The cash-on-cash return would be 10% (($10,000/$100,000) x 100%).

Here is a live exampe:

Total Investment ($) Net Annual Cash Flow ($)

Cash-on-Cash calculation for a Commercial Real Estate Project

Now, let's look at the concept in commercial real estate investment scenario. In commercial real estate investment, the operating revenues less the operating expenses is called Net Operating Income or NOI for short. To get the cash-on-cash, we also need to know annual financing payments, usually referred to as Annual Debt Service, to deduct from the Net Operating Income. Here is the formula:

Net Cashflow Income = NOI - Annual Debt Service Cash-on-cash return = (Net Cashflow Income / Initial cash investment) x 100%

Given the above, let's have a look at the live example below. Feel free to change the following numbers and see how things work for yourself:

Initial Equity:

Operating Revenues: Gross Annual Rental Income:

Operating Expenses:

Percent of Rental Income Fixed Operating Expenses

% of Operating Expense

Annual Debt Service:

NOI:		Net Cashflow:		Cash-on-Cash Return:

Limitations of Cash-on-Cash Return

It's important to note that cash-on-cash return only measures the profitability of the investment in terms of cash flow. It does not take into account other factors such as the potential appreciation of the property or the investor's debt service on the property.

Why Cash-on-Cash Return is Important

Despite this limitation, cash-on-cash return is a useful metric for comparing the profitability of different commercial real estate investments. It allows investors to see how well a property is performing in terms of its ability to generate cash flow, and it can help them determine whether an investment is meeting their financial goals.

Additionally, cash-on-cash return can be useful for comparing the profitability of different financing options for a commercial real estate investment. For example, an investor may be able to secure a higher cash-on-cash return by using leverage (borrowing money to finance the investment) and paying a lower down payment, but they will also have to consider the additional costs of debt and the risks associated with leveraging their investment.

Conclusion

In conclusion, cash-on-cash return is a valuable metric for evaluating the profitability of commercial real estate investments. It allows investors to see the percentage of their initial cash investment that is being returned as cash flow each year and can help them compare the profitability of different investments and financing options.

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