Cash-on-cash return example

Consider a property financed with $2 million in equity and a $4 million loan. If the property generates $400,000 per year of NOI with $200,000 in debt service, the cash-on-cash return would be 10%. 

If the same $6 million property was financed entirely in cash—and $0 in debt service—the cash-on-cash return would be lower: 6.7%.  

Using the cash-on-cash return metric in real estate

When evaluating investment properties, cash-on-cash return can help an investor assess the potential cash flow relative to the amount of equity required. 

It can also be useful for investors evaluating financing options and determining how to balance debt and equity in their capital stack. 

Cash-on-cash return should be one of several metrics used to evaluate an investment property, as it doesn’t tell you everything you need to know about an investment property. For instance, it measures returns during a particular period of time, usually a year. But it doesn’t account for changes to income and expenses over time or future capital investments in the property. 

Cash-on-cash return also doesn’t factor in potential equity growth as the investor pays down a loan or the property appreciates. It doesn’t consider the cash flow from a potential sale, either. 

Cash-on-cash return vs. cap rate

The capitalization rate, or cap rate, is calculated by dividing a property’s NOI by its current market value. Like cash-on-cash return, it represents a return for a particular period of time and can be used to compare properties. But it doesn’t account for financing. The cap rate would be equivalent to the cash-on-cash return for an investor paying all cash at the time of acquisition. 

Internal rate of return vs. cash-on-cash return

Cash-on-cash return measures an investment’s return in a particular time period. The internal rate of return (IRR) provides an annualized rate of return accounting for all cash flows an investor receives while holding a property. It can incorporate changes in income and expenses over time and expected proceeds from an asset’s sale. 

IRR also accounts for the time value of money. A dollar received today is worth more than the same dollar received a year from now because it can be invested, creating potential additional earnings.

However, an annualized rate of return can mask significant fluctuations in cash flow over time or the influence of the sale proceeds. 

What’s a good cash-on-cash return?

A real estate investor’s expected cash-on-cash return can vary by property type, location and market conditions. Goals matter, too. An investor primarily focused on generating cash flow may have a different benchmark than one focused on long-term appreciation. 

While real estate investors generally prefer a property with a higher cash-on-cash return, it’s also important to consider why the return is high. Increasing the debt in a property’s capital stack generally raises the cash-on-cash return, but that may not be sustainable.