Credibility, Accuracy, & Practical Value
Building the Business Case
Solution Matrix Ltd®

Cash on Cash Return on Investment
Definition, Meaning Explained, Usage, Example Calculations

 

Cash on cash ROI is a favorite metric of real estate investors, who often make short term investments with temporary use of long term loans.

The Cash on Cash ROI metric reveals the power of leverage when investing with borrowed funds.

What is Cash on Cash ROI?

The term cash on cash refers to a special form of return on investment analysis (ROI) restricted to the pre-tax cash portions (or capital portions) of larger investments.

Cash on cash ROI is frequently used for evaluating real estate investments, for instance, which typically involve long term borrowing. In such cases, the cash on cash ROI for an investor who buys and then sells a property during the life of the loan can be quite different from the ROI based on total investment costs.

Cash on Cash ROI Compared to Simple ROI in the Investment Context

Examples below compare cash on cash ROI with the more familiar ROI metric, simple ROI. Note especially that the examples show how investors increase or decrease profits by investing with borrowed funds or external funds. Cash on cash ROI, in other words, reveals the power of investor leverage.

Examples below illustrate cash on cash ROI in context with closely related investment terms, including:

Return on Capital
Simple ROI
Cost-Accurate ROI
Cash on Cash ROI
Leverage
Investor Risk

 

Contents

Related Topics


 

What is Return on Capital?

Businesspeople sometimes use the term return on capital, referring to a similar ROI approach for investments or costly actions where investment costs are partially borne by the investing company with its own capital, while the remaining costs are covered through loans, grants, tax incentives, or some other kind of external funding.

In such cases, return on capital ROI (just like cash on cash ROI) shows directly the return on the investor's own invested funds.

Note that "return on capital" used in this way should not be confused with a family of ROI-like profitability metrics that measure a company's ability to earn from its asset base or equity, such as return on invested capital (ROIC), return on capital employed (ROCE), or return on equity (ROE).

Investors Calculate Return on Investment ROI in Different Ways

Consider a property bought for $1,000,000 on 1 January. One year later, the investor sells it for $1,200,000. Those interested in this transaction typically take one of 3 different return on investment (ROI) approaches to evaluating this investment.

Investor ROI Metric 1
First Pass Simple ROI

A first pass simple ROI for this investment is derived entirely from the two figures given above:

Simple ROI = (Investment Gains – Investment Cost) / (Investment cost)
                      = (1,200,000 – 1,000,000) / (1,000,000)
                      = 20.0%

This approach might be used by an investor when making a first pass comparison between a large number of competing investments, simply in order to distinguish the best investment prospects from the worst.

Investor ROI Metric 2
Cost Accurate ROI

The first pass simple ROI does not include the full set of Investment costs. Costs besides the original purchase price will be incurred by the investor each year the property is owned. Moreover, these additional costs can be different from year to year. Consider for instance the other actual cash payments for investment costs made by the investor during this one year investment:

$2,400  Loan origination and loan closing fees
$9,600  Insurance and maintenance costs
$48,000 Twelve monthly loan payments ($38,000 interest + $10,000 principal)

These additional Year-1 costs total $60,000

Cost-accurate ROI = (Total Gains – Total Investment Costs) / (Total costs)
                      = (1,200,000 – (1,000,000 + 60,000 ) / (1,060,000)
                      = 13.2%

Note that if this property were an income-producing property, the total gains could be increased as well as the total costs, With such gains, the cost-accurate ROI would be higher than the 13.2% shown.

Investor ROI Metric 3
Cash on Cash ROI

Cash on cash ROI focuses only on the actual pre-tax cash inflows received and outflows paid by the investor by the close of the investment. Assume the following:

  • This example investment is not an income producing property. Otherwise the otherwise there could be gains in addition to the sale price of $1,200,000.
  • After one year, the investor's actual cash payments are as follows:

    $200,000  Initial down payment
    $2,400  Loan origination and loan closing fees
    $9,600  Insurance and maintenance costs
    $48,000 Twelve monthly loan payments ($38,000 interest + $10,000 principal)

    Total Cash payments = $260,000
  • After one year, when the property sells for $1,200,000, the investor's total cash payments are $260,000 (including the down payment), and the remaining loan balance after one year is $790,000.
  • When the investor pays off the $790,000 remaining loan balance from the $1,200,000 sale price, the total cash returns on this investment are $410,000.

The cash on cash ROI is thus:

Cash on cash ROI = ($Total cash gains – Total cash costs) / Total cash costs
Cash on cash ROI = ($410,000 – $260,000) / $260,000
                                   = 57.7%

ROI Conclusions
What is the Real ROI From This Investment?

What's the real ROI from this investment? The example figures above led to three different results for the same investment:

  1. First-pass simple ROI: 20.0%
  2. Cost-accurate simple ROI: 13.2%
  3. Cash on cash ROI: 57.7%

In reality, most investors choose base investment choices on results of the third metric above, the cash on cash ROI. Note, however, that none of the above ROI figures by itself considers investment risk, that is, the chance that the property will not appreciate in value as the investor hoped.

The Downside to Leverage: Greater Risk

For the investor who does perform a risk analysis, the cash on cash ROI is most useful for showing the range of possible investment outcomes. Suppose instead all of the same investment costs shown in this example, but instead of selling at a gain, the investor sells the same property after one year for the same $1,000,000 as the purchase price. In that case, the cash gains from the sale are $210,000 and cash on cash ROI becomes:

Cash on cash ROI = ($210,000 – $260,000) / $260,000
                                   =  –19.2%.

Or, suppose instead that the investor sells after one year for less than the purchase price, at $900,000. In that case, cash gains after the sale are $110,000 and cash on cash ROI is:

Cash on cash ROI = ($110,000 – $260,000) / $260,000
                                   =  –57.7%.

Winning vs. Losing with Leverage Depends on the Economy

Comparing the several cash on cash ROI figures shows most clearly the effect of leverage (operating with borrowed funds) on possible gains and possible losses, depending on whether the economy (or market prices) improves or worsens.

For more on defining and measuring leverage, see Leverage metrics. For numerical examples showing positive and negative results of leverage, see Capital and financial structure.

The premier Business Case Seminars

Business Case Master Class

Join the premier seminar on business case analysis. Earn professional education credit while building your case. Download case-building books and software when you register!

Join us in London, New York, or Washington DC.