Calculating Cash on Cash Returns in Commercial Real Estate Finance
A cash on cash return calculation determines the amount of annual income an investor earns on a piece of commercial real estate when compared to the amount of cash invested. Also called the equity dividend rate, this calculation is used as a basic yardstick for assessing a possible real estate investment. Generally in commercial real estate finance this number is most impacted by leverage since leverage determines the amount of cash required to enter into a commercial real estate investment (higher leverage = you can buy more with less money).
To calculate the cash on cash return, an investor first determines the net income from a specific property for the year. They can do this by determining the gross income the property generated and then subtracting any operating costs (and in the event there is a commercial mortgage, debt service as well). Then, they should divide the net income by the total cash spent for the property. The resulting figure, once converted to a percentage, is the cash on cash return.
The cash on cash return can vary greatly on the same real estate depending on how an investor finances the property. For example, if the investor spends $2 million buying a piece of property, their cash on cash return will be far lower than if they borrows $1.6 million and only spend their cash on a $400,000 down payment and closing costs.
Cash on cash return can be calculated by using the following formula:
Cash on Cash Return= Annual Dollar Income / Total Dollars Invested