Are you considering investing in a rental property and wondering how to calculate the potential cash on cash return? In this article, we’ll go over the basics of calculating the cash on cash return for a rental property so you can make informed investment decisions.
What is Cash on Cash Return?
Cash on cash return is a measure of the financial performance of an investment in real estate. It is calculated by dividing the net income generated by the property over a period of time by the cash invested in the property. The result is expressed as a percentage, which represents the rate of return on the cash invested.
How to Calculate the Cash on Cash Return for a Rental Property
Calculating the cash on cash return for a rental property is relatively straightforward. Here’s the formula:
Cash on cash return = (Net rental income / Cash invested) x 100
Net rental income is calculated by subtracting all operating expenses, such as property taxes, insurance, and maintenance costs, from the gross rental income. Cash invested refers to the cash used to purchase the property, including the down payment and any closing costs.
For example, let’s say you buy a rental property for $200,000 with a 20% down payment of $40,000 and closing costs of $10,000. The gross rental income is $24,000 per year and the operating expenses are $3,000 per year. The net rental income would be:
Net rental income = Gross rental income – Operating expenses = $24,000 – $3,000 = $21,000
Using the formula above, we can calculate the cash on cash return for the property:
Cash on cash return = ($21,000 / $50,000) x 100 = 42%
Factors That Affect the Cash on Cash Return for a Rental Property
There are several factors that can affect the cash on cash return for a rental property, including:
- Rental rate: The higher the rental rate, the higher the net rental income and the higher the cash on cash return.
- Occupancy rate: The higher the occupancy rate, the more likely the property will generate a consistent stream of rental income, which can increase the cash on cash return.
- Operating expenses: Lower operating expenses can increase the net rental income and the cash on cash return.
- Financing terms: The terms of the mortgage, such as the interest rate and length of the loan, can affect the cash on cash return. A lower interest rate or shorter loan term can result in a higher cash on cash return.
- Location: Properties in areas with high demand, such as popular vacation destinations or areas with strong job markets, tend to have higher rental rates and a higher cash on cash return.
Tips for Maximizing the Cash on Cash Return for a Rental Property
Here are a few tips for maximizing the cash on cash return for a rental property:
- Set a competitive rental rate: It’s important to research the rental rates in the area to ensure you’re setting a competitive rate that will attract tenants and generate a good return on your investment.
- Keep the property well-maintained: Properly maintaining and managing your property can help increase its value and generate higher rental income. This includes keeping the property in good condition, finding reliable tenants, and keeping up with necessary repairs and maintenance.
- Invest in high-demand areas: As mentioned above, properties in areas with high demand tend to have higher rental rates and a higher cash on cash return.
- Shop around for financing: It’s important to shop around and compare mortgage rates and terms to find the best deal and maximize your cash on cash return.
- Consider property management: If you don’t have the time or expertise to manage the property yourself, you may want to consider hiring a property management company to handle the day-to-day tasks. This can help maximize the rental income and cash on cash return, but be sure to factor in the property management fees when calculating the net rental income.
Conclusion
Calculating the cash on cash return for a rental property is an important step in evaluating the potential financial performance of a real estate investment. By using the formula outlined above and considering factors such as rental rate, occupancy rate, operating expenses, financing terms, and location, you can make informed decisions about your investments and maximize the cash on cash return for your rental property.