Cash-on-Cash (CoC) Return is a metric used in real estate investment to measure the annual return an investor makes on the cash invested in a property. It is calculated by dividing the annual pre-tax cash flow by the total cash invested.
where:
Example: Suppose you purchase a rental property for $500,000. You make a down payment of $100,000 and finance the remaining $400,000. If the property generates an annual pre-tax cash flow of $15,000, the CoC Return would be:
Using the same property, if the NOI is $30,000, the CAP Rate would be:
In reality, you need to account for closing costs and additional expenses before the property starts generating cash flow.
An 8% vacancy rate equates to approximately one vacant month per year. The average lease duration nationwide is 22 months, and you should anticipate at least one month for turnaround time between tenants. Additionally, property managers typically charge one month’s rent as a fee for their services.
A general rule of thumb is that expenses will be around 50% of your gross rental income. For taxes, refer to your local tax auditor’s website for specific information. Property management fees typically range from 6% to 10% of the monthly rent; remember, you get what you pay for. Insurance costs can be high, but you can always shop around for better rates by calling different providers for quotes.
CoC Return focuses on the return on the actual cash invested, while CAP Rate focuses on the return on the total property value.
CoC Return accounts for leverage (financing), making it more relevant for investors using mortgages.
CAP Rate is often used to assess the risk and potential return of a property without considering financing.
The CoC Return can be significantly higher than the CAP Rate due to the leverage effect. A high CoC Return might indicate efficient use of borrowed funds.
CoC Return and CAP Rate behave differently over time in rental investments. Initially, CoC Return is higher due to mortgage leverage. Rental income often increases with inflation, potentially boosting CoC Return. Once the mortgage is paid off, CoC Return can spike sharply since all rental income contributes directly to returns.
In contrast, the CAP Rate, which is the ratio of net operating income to property value, remains relatively stable unless property value or operating income changes significantly. While CoC Return fluctuates with mortgage dynamics and rental income, the CAP Rate is more steady, reflecting the property’s inherent value and income potential.
In essence, CoC return is like a fine wine—it gets better with age, especially as you chip away at that mortgage. Meanwhile, the CAP rate is more like a steady ship, cruising along based on the property’s inherent value and income.
Investors looking to maximize cash flow might prefer properties with high CoC Returns, while those focusing on long-term appreciation might prioritize CAP Rates.