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As a real estate investor, you're always looking for ways to maximize your return on investment (ROI). One metric that you may come across in your research is the "cash on cash return." But what is this metric and why does it matter? Let's take a closer look.

The cash on cash return is a ratio that calculates the cash income earned on the cash invested in a property. In other words, it tells you how much cash flow you're generating relative to the amount of money you've invested. This ratio is expressed as a percentage.

For example, let's say you invest $100,000 in a rental property and generate $10,000 in annual cash flow. In this case, your cash on cash return would be 10%.

Investors usually look for a return of 7-10% for the property to be a smart investment. Anything higher is a GREAT deal and anything lower can be achieved by investing in other things like the stock market.

How to Calculate Cash on Cash Return

There are two different ways to calculate this ratio. The first method is to simply divide your annual cash flow by your total investment. So, using our earlier example, if you invested $100,000 and generated $10,000 in annual cash flow, your calculation would look like this:

$10,000/$100,000 = 0.10 or 10%

The second method takes into account the fact that most people finance their investments with some combination of debt and equity. To account for this, we need to adjust our numerator (annual cash flow) and denominator (total investment) as follows:

Numerator: Annual Cash Flow - Total Debt Service

Denominator: Total Investment - All Debt Financing

Using this method, our earlier example would look like this:

$10,000 - $8,000 = $2,000/$100,000 - $80,000 = $20,000 or 20%

As you can see, when we take debt financing into account, our cash on cash return more than doubles! This is just one more reason why leverage can be such a powerful tool for real estate investors.

The Bottom Line

The bottom line is that the cash on cash return is an important metric to be aware of as a real estate investor. It will help you evaluate potential investments and make sure you're getting a good return on your money. Just remember that when calculating this ratio, you need to decide whether to use the "all-equity" method or the "leverage" method depending on how you're financing your investment. Whichever method you choose, just make sure you're consistent so that you can accurately compare different investment opportunities side-by-side.