In a previous blog, we talked about calculating cash flow. Establishing your cash on cash return is not the same thing. This is important because you need to understand how your hard earned dollars are working for you. You don’t want lazy dollars not bringing in return. Cash needs to be working hard and making you money. That’s the point of being an investor. Hold your cash accountable.
Let’s say your property is producing a cash flow of $250 per month. For 12 months, that’s $3,000 per year. You invested $30,000 in this property and you’re earning $3,000 a year on your cash. So what is your cash on cash return? Calculate the return by taking $3,000 and dividing it by $30,000, which is 0.1 or if you multiply it by 100, you get 10, or 10 percent. So, you’re getting a 10 percent return on your money. This is an easy way to calculate how hard your dollars are working for you. It means every single dollar is bringing back 10 cents every year. That’s pretty cool. You’re earning money off that property while you’re not the one paying the bill.
The great thing about calculating cash on cash return is that you can play around with your own numbers when you’re trying to decide what to buy. You know what you will have to spend on a property and what you’ll gain. Ideally, you’ll take your 10 best picks of subject properties you’re interested in. Look at the properties and figure out what kind of return they will be able to produce – maybe 10 percent or 12 percent or 15 percent. This will help you determine, based on these factors, which property is the best.
Cash on cash return is not the only thing to consider. It is one metric to pay attention to, but sometimes it makes sense to buy a property with lower cash on cash return because it’s a better property. Many times people will say they are getting cash on cash return of 30 percent. That means you have a property that cost very little and you don’t have a lot of money invested in it, but your rents are high. These properties are often low end properties and those prices are there for a reason. So maybe you paid $30,000, and someone gave you the money to buy it so you have $10,000 in the property. If it rents for $600, then you’ll see great cash on cash return. But that property rents for $600 for a reason. You won’t see actual returns because your property will produce cash flow and that’s it.
This is a great metric to measure deals, but it’s not the only one. If you’d like to talk more about this, please contact us at Bradstreet Proper.