# Buy and Hold Numbers: Cash-on-Cash Return

When you’re evaluating a rental property, it’s not enough to just calculate the cash flow to see if it’s a good deal or not. One can always put a larger down payment, reducing their debt payment, and therefore increasing their cash flow. When looking at a buy and hold rental property, an investor needs to consider what the cash-on-cash return is for a property.

In this post, we’ll dive into how to calculate the cash-on-cash return and how this metric varies based on whether an investor uses financing or not.

## Recap of Investor Joe

In Part 1 of our Buy and Hold Numbers post, we met part-time investor Joe who’s living and working full time in San Francisco.  Joe is analyzing a single family home out in the Mid West that he can rent out for \$1100 a month. Given Joe’s busy schedule and long distance from the property, he needs to rely on a property manager to handle the day to day operations of the property.

Here’s a quick summary of the cash flow we estimated last time using both a bottoms-up approach and when using the 50% rule to estimate expenses. For a more detailed description of the income and expenses you’ll find in your cash flow, check out Part 1.

Bottoms-up AnalysisMonthlyAnnual
Cash Flow (Income - Expenses)1341,604
Rent1,10013,200
Mortgage (P&I)-387-4638
Taxes-117-1400
Insurance-50-600
Maintenance (10%)-110-1320
Property Management (9% of collected rents)-99-1188
Lease Fee (assume new tenant in 2 years)-29-350
CapEx Reserve (new roof in 5 years)-83-1000
Vacancy (1 month)-92-1100

The objective of conducting a buy and hold analysis is to determine not only what the cash flow will be, but to also determine what’s the return on your invested capital?

If you’re only calculating a property’s cash flow, you only have half of the story. For instance, say you bought a property all cash and it’s generating \$700 a month of cash flow. Was that a good investment? Well, that depends.

Unless you know how much you invested in order to receive \$700 of cash flow a month, you aren’t in a position to say whether such an investment was good or not.

This is where the cash-on-cash (CoC) return comes in. CoC is expressed as a percentage and is a useful metric that quantifies the annual return of your initial cash investment.

One can easily calculate it using the following formula:

Cash-on-Cash Return = (Annual Cash Flow / Cash Invested) x 100

We already calculated the cash flow term in the above equation, but to estimate the return we’ll need to know how much cash will be invested?

The cash invested will depend on how the property is purchased. Let’s see how Joe’s return changes whether he’s financing his purchase or buying all cash?

From Part 1, we know that Joe was considering a property that costs \$90,000. Let’s say he’s planning to use bank financing to cover 80% of the purchase price, so he has to put down 20%, or \$18,000.  It’d be great if that was the end of it, but we have to also consider closing costs as well as any additional costs to get the property rent ready.

Closing costs will vary depending on the lender and the strength of the borrower, but in Joe’s case, let’s say his closing costs are approximately \$3,000. Also, while the property was recently renovated, it still needs a fresh coat of interior paint and some clean up that adds up to about \$1500.

In all, the total cash to be invested equals \$22,500 (\$18k + \$3k + \$1.5k). Therefore, the estimated cash-on-cash return would be 7.1% (\$1604 / \$22,500 * 100).

## Cash Purchase

On the other hand, what if Joe had a large sum of money sitting in his bank account?

Also, he has a friend who insists that all debt is bad and that he should just buy the house with all cash. His friend argues that in buying the house with no mortgage, his monthly cash flow would grow a ton. How much? Well, by paying all cash he would no longer have a \$387 monthly payment to make. This increases Joe’s cash flow to \$521 a month or \$6252 annually.

After hearing this argument from his friend, Joe’s leaning toward buying the house in all cash. Though just to be sure, before Joe makes up his mind he considers calculating the cash on cash return with this strategy.

As a cash purchase, the closing costs will be much lower since a bank won’t be involved. With bank financing, a large chunk of the closing costs go towards the loan origination fees, possible points to pay up front, pre-paid financing fees, and the cost of an appraisal. Some banks require borrowers to pay a full year of insurance up front as well as put into escrow additional cash reserves to cover taxes and insurance for 2 months. But with a cash purchase, much of these costs go away. Though a title transfer fee will still apply and an investor may still opt to have an appraisal done as well as a home inspection for their own peace of mind.

So in Joe’s case, with no bank involved, let’s assume his closing costs are reduced from \$3000 down to \$1500 since he’s paying all cash, but still wants a home inspection done.

The same \$1500 of initial cleanup and paint to make the property rent ready as compared to a financed purchase still applies.

Joe’s total cash invested with this strategy would be \$93,000 (\$90,000 + \$1500 + \$1500). Joe’s estimated annual cash flow is \$6252.

Therefore, his CoC (Cash-on-Cash) Return in using an all-cash strategy would be 6.7% (\$6,252/\$93,000 * 100).

Although the cash flow is significantly different (\$1604 vs \$6252), the cash on cash return (7.1% vs 6.7%) between both strategies have fairly similar results.

In Joe’s case, he has either option to pursue. So what does he do?

## Purchase Using Leverage or Buy All Cash?

This is a hotly debated topic and deserves its own post.

I will briefly say that in buying all cash, the higher monthly cash flow will provide a greater safety margin to withstand any emergency or large repairs that may turn up. Whereas if one is heavily leveraging themselves so that the monthly cash flow is only about \$100 or even less, then an investor can find themselves in a lot of trouble if a major repair unexpectedly shows up. Not to mention, if a property runs vacant longer than expected, the investor who’s financing will still need to continue making monthly mortgage payments whereas the cash investor will not.

Another advantage in purchasing with all cash is that cash offers tend to be much stronger. So a cash buyer may be able to purchase a property at a lower price than a buyer using financing.

On the flip side, financing allows an investor to leverage their money to buy even more real estate.

For example, let’s take Joe again. Instead of buying that 1 property all in cash for \$93,000, let’s assume there are 4 exact properties like this one. He decides to buy all 4 with leverage putting 20% down. The total cash invested to pick up all 4 would be \$90,000 (\$22,500 x 4). The total annual cash flow would be \$6,416 (\$1604 x 4). The cash-on-cash return is still 7.1% (6416/90,000 x 100).

He now controls 4 properties valued at nearly \$400,000 instead of just a single property valued at a quarter of that. A tenant living in each property paying rent and paying down your mortgage so that over time, you will own 4 properties free and clear. This is what leverage can get you.

There’s no right or wrong answer here.

Picking up properties using leverage or buying all cash largely depends on each investor’s personal situation, risk tolerance, and goals.

## Conclusion

When running the numbers on a potential buy and hold investment, we have a more complete picture of whether a property is a good deal or not if we calculate the cash flow and the cash-on-cash return. These 2 metrics can be calculated quite simply using the equations below.

1. Cash Flow = Income – Expenses
2. Cash-on-Cash Return = (Annual Cash Flow / Cash Invested) x 100

For simplicity, we haven’t included the effect of taxes or principal being paid down by the tenants paying us rent. I’ll cover these details in a future post.

### 8 thoughts on “Buy and Hold Numbers: Cash-on-Cash Return”

1. Great post. Very interesting comparison. I think with the cash purchase there is so much less risk. You mention the higher cash flow as a safety buffer and the vacancies. There is also the risk of having a lower credit score. Additionally, it is very difficult to leverage oneself perfectly and avoid becoming over leveraged. The great thing about cash only is that you will never have to worry about the bank taking the property. And you don’t have to even work with banks which are odious.

My analysis does show that there is more to the story though when you consider the NPV of the cash flows from a 100% financed property and the impact of depreciation and taxes. The interest creates a tax shield for some of your W-2 income and as long as the tenant is paying it you end up having an infinite return since there was no initial cash outlay. Obviously you still have vacancy risk, maintenance costs, and it is harder to cash flow the property. I also wouldn’t want more than one 100% financed deal due the high leverage.

• Thanks for that additional benefit of maintaining your credit score by buying properties all cash. Didn’t consider that one!

There are definitely tax advantages to owning real estate that you mention, though I’m not quite sure I follow when you say your interest creates a tax shield against W-2 income. My accountant treats my rentals by taking all the income and deducting all expenses (including taxes, depreciation, mortgage interest, etc.). If there’s a loss and it’s within the limits set by PAL (Passive Activity Losses) based on my MAGI (Modified Adjusted Gross Income), he can deduct the loss against my W-2. So did you mean your entire loss (not just interest) can create a tax shield against W-2 income?

But yes, infinite returns sounds very enticing. I think 100% financing can work if one is able to buy well below the market value of a property (e.g. 20% below), because they’d have built in equity. It’d be no different then a retail buyer putting down 20% on a home priced at full market value.

2. You are so tolerant of both views! I am a bit more harsh, taking the stance that people who pay cash with a 10+ year time frame on their investment don’t get it.

-the risk is from not covering the mortgage, so pay the minimum and hold more reserves
-a house that appreciates at 2-3% a year (with inflation, as expected over a long time period in a low cost / non-bubble city) with leverage returns you 10-15% if you put 20% down
-same appreciation, no leverage you get the exact 2-3%. And considering that is the rate of inflation, you didn’t actually gain any purchasing power from appreciation. Kiss it goodbye.

So if you don’t use a mortgage, you are giving up the largest component of gains (cash flow, appreciation, taxes, paying down the mortgage)!

• Haha, I knew someone would jump into the all cash vs leverage debate! My intention wasn’t for making a case for one or the other, but rather just an introductory post on cash-on-cash returns. As I said in the post, it all comes down to each investor’s personal situation, risk tolerance, and goals.

When you’re young, fearless, and your primary goal is to build wealth, then absolutely I think you should take advantage of leverage. You’ll accumulate properties faster with less capital, apply more tax deductions, and your overall returns will be higher.

But later in your life, a leveraged approach that optimizes the long game may just not make sense for someone nearing their retirement. At that stage in life, one may prefer a much higher cash flow to build a greater safety margin as well as less risk exposure by not taking out 30 year loans.

I can’t tell you how many times I’ve talked with an experienced, older investor who’s advice to new real estate investors is to not over leverage. “Cash is what keeps you in the game and buys you staying power through the tough times,” they say. It’s a common theme I hear.

What’s common from young folks like us, is an optimism that everything will just work out. We say to ourselves, “I’m smarter than that. I’ll buy it right, be conservative with my analysis, have enough cash flow, and hold reserves”. Trust me, I think this way too. Though no one knows when a disaster strikes. And if we have 4 recourse loans and default on one, then all of our personal assets are at risk too.

That’s what having a margin of safety is for. Lifelong investors seem to know this lesson all too well.

With that being said though, personally, I use leverage and I’ll continue to do so. I’m young and trying to build wealth. But I’m taking on debt as appropriate and trying to do so in moderation.

3. Hmmmm. It seems pretty clear to me. I’ve seen the info-mercials at night. If you use loans and buy 4 houses instead of one, you can make a lot of money!!! You’ll be rich!! But that’s only if things go your way. You need to count on appreciation, keeping them rented out, no big unexpected expenses, no surprises with you job or health. Too bad things rarely work out that way!!! This is more likely:

Something unexpected happens, (insert random unexpected event here). You miss some payments. Something else unexpected happens, you can’t get rid of a bad tenant. You miss some more payments. You eventually lose all four homes and your credit. Your wife runs off with your best friend. Your dog runs away. They write a country song about you.

Buy with cash. That’s what I do. I’ve bought several homes with cash on a military income. It’s takes longer, but it’s safe. Loans suck. Its debt. It’s not good debt, because good debt doesn’t exist. Just my two cents.

• Thanks for sharing your perspective Rich. I agree, having loan payments suck. So what price range are your rental property investments that you buy with all cash?

So how do you feel about using leverage for multifamily properties? I don’t know any investor who buys apartments without using some form of leverage. Either they use leverage to finance the purchase upfront or they buy all cash and then later do a cash-out refinance to pull out much of their initial cash investment. In both cases, leverage is being used for the long term. I’d be interested to hear what your thoughts in this case.

• The ready to rent price ranges from \$40-60k. It makes all cash much easier. These are in Alabama. I did have a house in dc that i paid \$280k for, and paid it off in 6 years.

I’m against leverage in all cases. I believe that, if you “need” to use a loan to buy your first rental property, you should pay off that loan asap before buying your second. At a certain point, the cash flow begins to snowball, and you are buying houses for cash at a faster and faster rate. I’m also for paying off primary residences (even better, rent instead of owning a primary residence)

If I felt the need to buy an apartment complex, I would sell some existing houses and pay cash for it. This way you avoid the risk of defaulting on a loan, and you sleep better at night. It’s more conservative. You might not get rich quick, but you will get rich eventually.