Cash on cash return is a real estate term related to cap rates, but accounts for leverage when determining an investor's actual return on investment.
Cash on cash return takes into account the fact that investors typically use part down payment and part loan in order to buy a piece of real estate. So, cash on cash return really tells us the return on investment to the investor after accounting for leverage.
Let's take a look at the formulas, and then we'll work through it and see how it's related.
Cash-on-Cash Return = Net Cash Flow / Down Payment
Net Cash Flow = Net Operating Income - Debt Service
Down Payment = Purchase Price - Loan Amount
Cash on cash return, often expressed as C over C, is simply our net cash flow after debt service divided by the down payment. We arrive at this formula by extrapolating it from another formula. So let's take a look at it. It's actually our net operating income minus our debt service, over our value, or purchase price, minus our loan amount.
Imagine here we have $80,000 of net operating income and we have $45,000 in annual debt service. That gives us $35,000 of net cash flow. If our purchase price was a million and we leveraged 750,000 of that, then our down payment would be 250,000. So our net cash flow divided by our down payment would equal approximately 14%.