Definition: Cash on cash return, also known as equity dividend rate, refers to the rate of return on real estate investments, and it is calculated by dividing the cash flow before tax over the equity invested.
What Does Cash on Cash Return Mean?
What is the definition of cash on cash return? Cash on cash return is the cash income that an investor earns on a real estate investment. For instance, if an investor purchases a second home for $200,000, he can pay 20% as a down payment and take a loan of $160,000. CCR is also useful for estimating the leverage effect when using a mortgage loan to finance the purchase of the property. To calculate cash on cash return formula, we need to know the net operating income, equity, and the value of mortgages.
Let’s look at an example.
Doris wants to purchase a retirement house for $280,000. She puts a down payment of 40%, and she takes a mortgage of $168,000 at an annual interest rate of 6.8%. In addition, she pays $7,000 in closing fees, $8,400 for maintenance costs and $ 13,300 for property insurance. However, she plans to rent the house for a couple of years until she feels more stable with her finances.
Her banker creates an Excel spreadsheet for her to help her understand what is the CCR, and what is the effect of the mortgage on her return.
Doris pays in cash $112,000 (280,000 x 40%). Her banker estimates an effective gross income from renting the house at $60,000. Therefore, the property’s net operating income is $60,000 – $7,000 – $8,400 – $13,000 = $31,300. Hence, the CCR is $31,300 / $112,000 = 27.9%
Since Doris is financing the property purchase with a mortgage, her banker calculates the effect of leverage as follows:
Net operating income = $60,000 – $7,000 – $8,400 – $13,000 = $31,300. Now, the banker deducts the interest payments as well, so the net operating income is $31,300 – $11,340 = $19,960. Hence, the effect of leverage in this case is $19,960 / $112,000 = 17.8%.
Note that in both cases the denominator is the cash amount paid and not the cost of the property.
Define Cash on Cash Returns: Cash on cash return means a performance ratio used to measure the money earned on the money used for a real estate investment.