What Is Cash-on-Cash Yield?
Cash-on-cash yield is used to estimate the return from an income-generating asset. This metric is commonly used to calculate returns for real estate investments. It measures the annual pre-tax cash flow from the investment as a percentage of the initial cash invested. The formula is
Cash-on-cash yield = Annual pre-tax cash flow / Total cash invested
For example, if an investor earns $10,000 annually on a $100,000 cash investment, the cash-on-cash yield is 10%. This metric is also used to compare income trusts, referring to the total distributions paid annually as a percentage of the current price, and is sometimes called cash-on-cash return.
Key Takeaways
- Cash-on-cash yield helps estimate the return on real estate investment by comparing annual net cash flow to invested equity.
- This metric is useful in evaluating the performance and value of commercial real estate assets.
- Cash-on-cash yield doesn’t account for depreciation or appreciation, focusing solely on actual cash return.
- Limitations include potentially overstating yield if part of the distributions contains a return of capital.
- Real estate investors often use cash-on-cash yield for property valuations and investment performance assessments.
How to Calculate Cash-on-Cash Yield
Cash-on-cash yield is useful as an initial estimate of the return from an investment and can be calculated as follows:
Cash-on-Cash Yield = Annual Net Cash Flow ÷ Invested Equity
For example, if an apartment priced at $200,000 generates a monthly rental income of $1,000, the cash-on-cash yield on an annualized basis would be 6% ($1,000 x 12 ÷ $200,000 = 0.06).
In the context of income trusts, assume a trust with a current market price of $20 pays out $2 in annual distributions, consisting of $1.50 in income and 50 cents in ROC. The cash-on-cash yield in this case is 10%; however, since part of the distribution consists of the return of ROC, the actual yield is 7.5%. The cash-on-cash yield measure overstates the return in this case.
Deep Dive Into Cash-on-Cash Yield Mechanics
As noted above, a cash-on-cash yield is the return generated by an income-producing asset. It is commonly used to describe the return of commercial real estate assets—notably income or investment properties. As such, real estate investors and professionals use this metric to measure a property’s investment performance. It is also used to determine annual distributions paid by income trusts as a percentage of their current price.
An asset’s cash-on-cash yield can also be used to make projections or forecasts about an asset’s future returns. It’s an estimate, not a guaranteed return. As such, investors can use the formula above to calculate what they may earn as a return over the life of the investment.
Unlike other metrics, cash-on-cash yield considers debt payments. But the cash-on-cash yield has certain limitations. The metric may overstate yield if part of the distribution consists of a return of capital (ROC), rather than a return on invested capital (ROIC). This is often the case with income trusts. It doesn’t account for taxes as a pre-tax measure of return.
Using Cash-on-Cash Yield in Real Estate Valuation
Cash-on-cash yield is often used in the real estate market when valuing commercial properties, particularly ones that involve long-term debt borrowing. This yield can also be used when determining if a property is undervalued. When debt is involved, the cash return differs from the standard return on investment (ROI).
Cash-on-cash yield excludes appreciation or depreciation. While ROI includes total investment return, cash-on-cash focuses solely on cash invested.
Fast Fact
A cash-on-cash yield is different from a monthly coupon distribution. Rather than being a fully promised outlay, it can only be used as an estimate to assess future potential.
Real Estate Cash-on-Cash Yield: An Example
Suppose a real estate company purchases a property for $500,000. It spends a further $100,000 on repairs to the building. To finance its purchase, the company makes a down payment of $100,000 and takes out a loan of $400,000 with yearly mortgage payments of $20,000. The company earns $50,000 in rental income during the first year.
The calculation for its cash-on-cash yield begins with cash flow. The cash flow for the company is $50,000 – $20,000 = $30,000. The total amount invested in the building is $220,000 = $100,000 (down payment) + $100,000 (repairs to the building) + $20,000 (mortgage payment). The building’s cash-on-cash yield is 13.6% ($30,000 ÷ $220,000).
What Is a Good Cash-on-Cash Yield?
There isn’t an easy answer to this question. What makes a good cash-on-cash yield depends on the investor and several factors, including the property’s location, market conditions, and an investor’s risk tolerance. Some people generally consider a range of 7% to 10% to be an acceptable
What’s the Difference Between Cash-on-Cash Yield and Internal Rate of Return?
A cash-on-cash yield can be used to determine an income-producing asset’s return. It is normally used to calculate and project returns for real estate investments, including properties and income trusts. An internal rate of return (IRR) calculates an investment’s expected return. While the cash-on-cash yield is used to determine an investment’s annual return, the IRR is used to show an investor the return they can earn during the lifetime of the investment.
What Are the Limitations of Cash-on-Cash Yield?
Real estate investors can use an asset’s cash-on-cash yield to help them determine its investment performance. But, the yield can be overstated because it may not account for certain factors, including taxes a pre-tax measure of return.
The Bottom Line
Cash-on-cash yield offers investors a quick way to estimate returns on income-generating assets, especially in real estate and income trusts. It’s calculated by dividing annual net cash flow by the total equity invested, making it useful for comparing potential opportunities like commercial properties.
However, it can overstate returns if part of the distribution is a return of capital, and it doesn’t account for taxes, appreciation, or depreciation, so it should be used as an initial comparison tool rather than a full measure of total return.
