Cash-on-Cash Yield Definition

What is the cash-on-cash return?

Cash-on-cash yield is a basic calculation used to estimate the return of an asset that generates income. Cash yield also refers to the total amount of distributions paid annually by a income trust as a percentage of its current price. The cash-on-cash return is a measurement technique that makes it possible to compare different unit trusts.

This term is also referred to as “cash-on-cash return”.

Key points to remember

  • Cash-on-cash yield is used to calculate the return on an asset that generates income. It is widely used in valuations of commercial real estate calculations.
  • It can be used to determine if a property is overvalued or undervalued. But this is not a fully promised expense.
  • It cannot be entirely relied upon for accuracy as the measure may overestimate the return if part of the distribution consists of a return on capital (ROC) instead of a return on invested capital (ROIC).

Understanding cash-on-cash yield

The cash-on-cash return is useful as an initial estimate of an investment’s return and can be calculated as follows:

Cash-on-cash return = annual net cash flow / invested equity

The cash-on-cash return has a number of limitations. The measure may overestimate the return if part of the distribution consists of a “return of capital (ROC)“Rather Than One”return on invested capital (ROIC)as is often the case with income trusts. Also, as a measure of pre-tax return, it does not take taxes into account.

For example, if an apartment priced at $200,000 generates monthly rental income of $1,000, the cash-on-cash return on an annualized basis would be: 6% ($1,000 * 12 / $200,000 = 0.06).

In the context of income trusts, assume it is a trust whose market price of $20 earns $2 in annual distributions, or $1.50 of income and 50 cents of ROC. The cash-on-cash return in this case is 10%; however, since part of the distribution consists of an ROC return, the actual return is 7.5%. The cash-on-cash yield measure overestimates the yield in this case.

Cash-on-cash return and real estate value calculations

Although cash-on-cash yield can be used in a number of circumstances; the measure is often used in the real estate market when valuing commercial properties – especially those that involve long-term borrowing. Cash yield can also be used to determine if a property is undervalued. When debt is recognized in a real estate transaction (as is usually the case), the actual cash return of the investment differs from the standard return return on investment (ROI).

The cash-on-cash return does not include any appreciation or depreciation of the investment. Calculations based on the standard ROI will incorporate the total return on an investment; on the other hand, the cash-on-cash return simply measures the return on real money invested.

Unlike a monthly coupon distribution, the cash-on-cash return is not an entirely promised expense. When forecasting, a cash-on-cash return can only be used as an estimate to gauge future potential.

Example of cash-on-cash return

Suppose a real estate company buys a building for $500,000. He spends another $100,000 on building repairs. To finance its purchase, the company put down a down payment of $100,000 and took out a loan of $400,000 with annual mortgage payments of $20,000. The business earns $50,000 in rental income in the first year.

The calculation of its cash yield begins with the cash flow. The company’s cash flow is $50,000 – $20,000 = $30,000. The total amount invested in the building is $220,000 = $100,000 (down payment) + $100,000 (building repairs) + $20,000 (mortgage payment). The building’s cash-on-cash return is 13.6% ($30,000/$220,000).

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