Understanding Cash on Cash Returns and Simple Returns in Real Estate Investing

When it comes to real estate investing, understanding cash on cash return and simple return metrics stand out for their simplicity and effectiveness in providing investors with a clear picture of their investment’s profitability. 

Cash on Cash Returns:

Cash on cash return is a popular real estate investment metric used to evaluate the cash income earned on the cash invested in a property. It's particularly useful for investors who finance their properties with mortgages, as it considers only the actual cash invested, offering a more accurate measure of the investment’s immediate profitability.

Calculation: The cash on cash return is calculated by dividing the annual pre-tax cash flow by the total cash invested.

Practical Example

Suppose you purchase a rental property for $200,000. You make a down payment of $40,000 and incur $10,000 in additional closing costs and renovation expenses, bringing your total cash invested to $50,000.

Annual Rent and Expenses: You rent out the property for $2,000 per month ($24,000 annually). After accounting for expenses such as property management, maintenance, and taxes, your annual pre-tax cash flow is $14,000.

Cash on Cash Return Calculation: $14,000 divided by $50,000 equals a cash on cash return of 28%

This means you are earning a 28% return on the cash you have invested in the first year.

This metric is expressed as a percentage, providing a straightforward way to compare the cash flow of different investment opportunities.

Simple Return: Basics and Application

Simple return, on the other hand, is a broad metric used across various types of investments, including real estate. It measures the total return on an investment over a period without considering the compound interest.

Calculation: The simple return is calculated by subtracting the initial investment from the final value of the investment (including any cash flows received), then dividing by the initial investment.​

This metric is also expressed as a percentage and offers a quick way to assess the overall growth of an investment over a specified period.

Simple Return Calculation: Using the same property example above. After one year, suppose the property appreciates in value and it nets you $10,000 profit after you sell. The final one year return of your investment, including the cash flow received, is $24,000 ($10,000 from the sale plus $14,000 cash flow).

Simple Return Calculation:  $24,000 divided by $50,000 (original cash invested), equals a total simple return of 48%

This example demonstrates a higher simple return, largely due to the property's appreciation. However, this metric also reflects the total growth of the investment, not just the cash income.

Conclusion

Both cash on cash return and simple return metrics are invaluable tools for real estate investors, offering distinct perspectives on an investment’s performance. Cash on cash return is particularly useful for evaluating the efficiency of cash invested in generating income, while the simple return provides a broader view of the investment’s total growth over time. Understanding and applying these metrics can greatly enhance investment decision-making, allowing investors to more accurately assess and compare potential real estate opportunities.