The language of investments should be a requirement for all matriculating students. With so many terms and formulas floating around it can be especially challenging to figure out what to do with your money and how your money can make money – so that you can save money for the future. One important term for you to know if you want to become an investor is the meaning of cash-on-cash returns.
Basically a cash-on-cash return is a formula that determines the amount of cash a person can generate on a cash investment. The term is often reserved to describe the cash flow from income-producing assets, like rental real estate properties. Investors use the formula to value the moneymaking capabilities of investment properties providing cash flow. It is also used to determine if a property is under priced.
If you were considering making cash investment into a rental property, it would be important to calculate the cash-on-cash return number to see if the investment is a wise choice. For example, say you are going to buy a rental property costing $1,000,000 with 25% cash down, or $250,000. The units rented would generate $9,000 monthly or $108,000 in pre-tax income. Take the expected income and divide it by the cash down and that would provide you with a 43% rate of cash-on-cash return.
The above cash-to-cash return scenario is simplistic at best. There are many things to consider before making an investment into properties. Every person has a unique tax situation, so before making any type of investment, large or small, it is important to run the scenario by your personal tax expert to see how you may be affected in the long run. Additionally, the state of the building and all the operating expenses must also be taking into account.
However a cash-to-cash return calculation is a simple way to gauge, whether or not an investment returning cash dividends is going to be worth it in the long run. It is just a starting point, so use it wisely.