Cash on Cash Return, or sometimes known as CCR for short, is the percentage of cash you get back from a cash investment in a given year.
Simply put, the equation is as follows:
Annual Cash Flow Received
CCR = ———————————————
Total Cash Invested
The Annual Cash Flow Received is the amount of cash that returns to your pocket every year. The Total Cash Invested is how much total cash you had to cough up in order to get ahold of the investment. This is an important percentage since you can evaluate and compare the myriad of real estate investments in your area with a common measurement.
Let’s say you put purchased a $100,000 rental property and paid $20,000 down on it. You rented it out for $1,000 a month, which is nice, but you also incurred operating expenses of $881. After all is said and done for the month, you ended up with $119 cash flow a month, which is real cash in your pocket. (Remember, if you are struggling with cash flow, there is a great blog post that explains it here.)
$119 a month does not sound like a lot of money, but let’s look at our Cash on Cash Return (CCR). Before going too far, let’s recall that we need the annual cash flow for our simple equation above:
$119 / month * 12 = $1,428 / year
Now that we know our yearly cash flow, let’s revisit that calculation above. Recall that we put $20,000 down on the property
CCR = $1,428 cash flow / $20,000 invested
CCR = 7.14/100 = 7.14%
Okay, when you put it that way, $119 a month doesn’t sound so bad. You’re getting a 7.14% return on your $20,000 you invested into this property! Remember that this cash flow number is also assuming you will have a month of vacancy per year and will have repair costs. Although the cash return is nice, don’t forget that you are most likely getting Depreciation, Equity, and Appreciation on this investment as well.
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The Rule of 72
One rule in finance, and in real estate investing as well, is the rule of 72. Yes, there are many rules and “guidelines” out there, but this rule is meant to be an easy estimator requiring only division. Determine how many years it will take to double your money by dividing 72 into the amount identified by your rate of return, or Cash on Cash Return (CCR) in this example:
72 / 7.14 = 10 Years
With this simple rule of thumb, it’s easy to estimate that it will take 10 years for you to get your money back out of your investment. You don’t need complicated spreadsheets or mortgage calculators and there’s no need to wrestle around with compound interest equations! The Rule of 72 isn’t perfectly accurate, but it is designed to give you a quick estimate on when you can pull your cash back out of the investment.
Although there are no (or low) money down investments out there, most of your dealings are going to require some cash outlay. In order to manage your cash flow and compare future property investments that suit your criteria, you’ll want to be able to compare properties that seem to have the best rates of return and use the Cash on Cash Return percentage to narrow them down.
Continue reading our Real Estate Investing Terms to Know series and check out Net Operating Income (NOI)!
(Photo Credit: TaxCredits.net)