This is the third of three formulas for buying rental property. In this article I will compare the cash-on-cash returns for the rental purchases described in the previous two articles.
The cash-on-cash return is the ratio of annual before-tax cash flow to the total amount of cash invested, expressed as a percentage.
CASH-ON-CASH RETURN = ANNUAL BEFORE-TAX CASH FLOW / TOTAL CASH INVESTMENT
Example 1: BUY A RENTAL WITH LOAN FORMULA
Suppose you purchase a $150,000 rental with a $30,000 down payment and $20,000 in closing, finance, holding, and fix-up costs for a total cash investment of $50,000. You finance the balance of $120,000 for 4% APR on a 30 year fixed rate loan. Each month, the cash flow from your rental, less expenses, is $427. Over the course of a year, the before-tax income would be $427 × 12 = $5,124 so the cash-on-cash return would be
_______ = .10248 = 10.25%
Example 2: BUY A RENTAL WITH CASH FORMULA
Suppose you purchase a $150,000 rental with a $150,000 cash and $16,000 in closing, holding, and fix-up costs for a total cash investment of $166,000. Each month, the cash flow from your rental, less expenses, is $1,000. Over the course of a year, the before-tax income would be $1,000 × 12 = $12,000 so the cash-on-cash return would be
_______ = .072289156 = 7.23%
You will get a higher rate of cash-on-cash return (10.25%) by financing 80% of the purchase at 4% APR.
You will get a lower rate of cash-on-cash return (7.23%) by paying cash for the property.
You will get a higher monthly income if you pay cash.
*LIMITATIONS TO CASH-ON-CASH CALCULATIONS:
It is possible to perform an after-tax Cash on Cash calculation, but accurate depictions of your adjusted taxable income are needed to correctly address how much tax payment is being saved through depreciation and other losses. It is always advisable to consult with your CPA or tax preparer before buying real property for investments purposes.
*Most of the text for this “Limitations” section and certain phrases used earlier were adapted from the Wikipedia article titled Cash on Cash Return.
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