What cash-on-cash return tells you
Cash-on-cash return is the cash a rental puts in your pocket in a year, divided by the cash you put into the deal. It answers a simple question: for every dollar I invested, how many cents come back each year before taxes? Unlike the cap rate, it includes your mortgage, so two buyers of the same building can get very different results.
The formula
- Total cash invested = down payment + closing costs + rehab or initial repairs + loan points
- Annual pre-tax cash flow = net operating income (NOI) − yearly mortgage payments
- Cash-on-cash return = annual cash flow ÷ total cash invested
- Payback period = total cash invested ÷ annual cash flow (ignoring any change over time)
NOI is rent collected after vacancy, minus operating costs such as taxes, insurance, repairs, management and owner-paid utilities. It leaves out the mortgage, depreciation and income taxes.
Worked example
You buy a $400,000 rental with 25% down, $12,000 of closing costs, $10,000 of initial repairs and 1 point on a $300,000 loan at 7% for 30 years. Rent is $3,400 a month, you allow 5% for vacancy and operating costs are $12,000 a year.
| Line | Amount |
|---|---|
| Down payment (25%) | $100,000 |
| Closing costs + repairs + points | $25,000 |
| Total cash invested | $125,000 |
| NOI ($40,800 rent − 5% vacancy − $12,000) | $26,760 / yr |
| Mortgage payments ($1,995.91 × 12) | −$23,951 / yr |
| Annual pre-tax cash flow | $2,809 |
| Cash-on-cash return | 2.25% |
| Payback period | 44.5 years |
Bought all cash, the same property costs $422,000 up front and yields $26,760, or 6.34%. Borrowing cut the return to 2.25% because the loan payments equal about 7.98% of the loan balance each year, more than the 6.34% the property earns on its cost. That is negative leverage.
Why the sensitivity table matters
Small changes move cash-on-cash return a lot when cash flow is thin. In the example:
| Rent | 6% rate | 7% rate | 8% rate |
|---|---|---|---|
| $3,230 (−5%) | 2.59% | 0.70% | −1.27% |
| $3,400 | 4.14% | 2.25% | 0.28% |
| $3,570 (+5%) | 5.69% | 3.80% | 1.83% |
A 5% drop in rent with a one-point higher rate turns the deal cash-flow negative. Stress-test your own numbers before you rely on the middle cell.
Limits
- It is a year-one, pre-tax snapshot. Rent growth, loan paydown, appreciation and depreciation are left out.
- Reserves you set aside for future repairs count as cash invested only if you include them yourself.
- If cash flow is negative, the return is negative and there is no payback from cash flow alone.
Next steps
Build a monthly budget in the rental property cash flow calculator, check whether a lender will cover the payment with the DSCR calculator, or model pulling your cash back out with the BRRRR calculator.