Using Cash on Cash Return to Analyze Your Investment Property

Each real estate investor uses their own unique set of ration to analyze investment property purchases. Some of those ratios include: Cash on Cash Return, Debt Coverage, Cap Rate, Gross Multiplier, and Return on Asset to name a few. Your financial goals, risk tolerance, and the type of property you are interested in with ultimately determin Which ratio you use.

Many of the required numbers for calculating Cash on Cash return are easily available in the field or on the fly, many investors will use this ratio as a quick test to determine if further analysis is required. It is an excellent indicator if the property is potentially under priced or a cash cow. Less seasoned investors may want to use a an on-line property analysis tool or property worksheet to do the work for them.

The math equation for Cash on Cash Return is Net Annual Cash Flow divided by Total Cash Invested. Let's work through gathering the numbers.

First, calculate the Net Annual Before-Tax Cash Flow:

Calculate your yearly income from the property including rent and additional income such as laundry fees.
Total all yearly expenses that you pay as the owner/landlord such as:
Utilities (heat & electricity)
Water/Sewer/Garbage
Snow/Lawn Care
Management/Care taking
Insurance
Subtract the above yearly expenses from your above yearly income to arrive at your Net Annual Operating Income.

Next:
Calculate your mortgage payment using any on-line mortgage calculators. Multiply by 12 to get your annual mortgage payment.
Subtract your annual mortgage payment and your annual tax amount from the above Net Annual Operating Income to arrive at your Net Annual Cash Flow. Make sure you did not include taxes more than once!

Figuring your Total Cash Invested is easy. It is simply amount of money your used to acquire the property [think down payment]. Most investors will keep the math simplified by NOT including closing costs or other 'acquisition costs'.

Last:
Calculate your Cash on Cash Return by simply divide Net Annual Cash Flow by Total Cash Invested. This percentage/ratio can used to compare even un-like investments. Looking at it simplistically, this number shows how much of your cash out of pocket is returned to you each year by this investment. Because this is a quick test, it does not take into account any tax implications, depreciation, or appreciation.

I recommend that you run multiple examples to become familiar with this ratio before making a purchase decision using it. You should also become comfortable with what level of Cash on Cash Return you are striving for. Many real estate investors are looking for at least a 24% Cash on Cash Return. Some will not even consider a property unless it produces a ratio of 30% or greater.

Article Source: http://www.propertymagnate.com/articles

Scott Ficek owns and manages almost 30 investment property units from single family to multi-family. He is also a Minnesota MLS Agent with RE/MAX Advantage Plus in Minneapolis and helps new and seasoned investors buy and own Investment Real Estate.

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