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It is often used to evaluate the cash flow from income-producing assets. Generally considered a quick napkin test to determine if the asset qualifies for further review and analysis. Cash on Cash analyses are generally used by investors looking for properties where cash flow is paramount, however, some use it to determine if a property is undervalued, indicating instant equity in a property.
Suppose an investor purchases a $1,200,000 apartment complex with a $300,000 down payment. Each month, the cash flow from rentals, less expenses, is $5,000. Over the course of a year, the before-tax income would be $5,000 × 12 = $60,000, so the NOI (Net Operating Income)-on-cash return would be
However, because the investor used debt to service a portion of the asset, they are required to make debt service payments and principal repayments in this scenario (I.E. mortgage payments). Because of this, the Cash-on-Cash return would be a lower figure which would be determined by dividing the NOI after all mortgage payment expenses were deducted from it, by the total cash invested.
For example: If the investor made total mortgage payments (principal+interest) of $2,000 a month in this scenario, then the Cash-on-Cash investment would be as follows: $2,000x12= $24,000. $60,000-$24,000= $36,000. .
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.