Posted in Finance, Accounting and Economics Terms, Total Reads: 201
Definition: Cash on Cash Return
Cash on Cash Return is defined as a commonly used rate of return computed during real estate transactions which evaluates the cash flow from income-producing assets. However, cash-on-cash return can be used in general investing terms as well, it qualifies as a quick handy test to determine if the asset qualifies for further analysis and review.
It is also known as the equity dividend rate in some contexts, when referring to non-real estate related investments.
Common utility of the cash-on-cash return formula is to evaluate properties in real estate transactions and also investments where cash flow is the critical factor. At times, this parameter can be used to determine if an asset or property is underpriced, i.e it is a benchmark indicator.
The Cash-on- cash return is computed as = Annual Dollar Income/Total Dollar Investment, expressed as a percentage. This formula determines the cash income on the cash invested. The cash-on-cash return measure can be calculated on both pre-tax and after-tax basis for the annual income
For example, consider person A purchases a rental property, and puts down 10% of the cost as a cash down payment. Hence here cash on cash return would measure the actual return made on the property in relation to the down payment.
Advantages of the Cash-on-cash return measure
• It shows the effect of leverage well, especially in the case of mortgage as in the case of real estate transactions.
• Quick and handy measure to access investment suitability.
Limitations of the Cash-on-cash return measure
• The formula does not take into account, appreciation and depreciation, hence the return on capital computed, can be a deceptive indicator.
• It does not account for extraneous risks
• Ignores the effect of compounding, in returns.
• Does not take into account, the income tax effects, resale implications, reductions in loan principal or future cash flows.