What is a Good Cash-on-Cash Return?

When you’re weighing your options on where to invest your money, there’s a lot to consider. You might start by comparing the return on investment (ROI) between different types of investments. While cash-on-cash (CoC) returns are one big piece of the puzzle when looking at the benefits of a particular asset class, they aren’t the full picture. We’ll talk about cash-on-cash returns, what to expect now versus what we saw over the past few years, and what to consider alongside CoC when comparing returns for different asset classes.  

What are cash-on-cash returns?  

A cash-on-cash (CoC) return looks at the profitability of an investment company. Calculate cash on cash by dividing the annual cashflow by the total cash invested in the property. The annual cashflow is a calculation of the gross rent received, minus all operating expenses, which can include costs like insurance, payroll, maintenance, and property taxes minus debt service and all non-operational expenses.

In 2020 and 2021, even into early 2022, real estate investors were used to seeing CoC returns of 8-10%. Since then, with higher interest rates, increasing expenses from inflation and supply chain issues, and a slowdown in rent growth, net cash flow has decreased. In 2023, investors can expect to see CoC returns in the 6-7% range which is still strong compared to other investment options.

A strong cash-on-cash return will depend on the type of property you invest in, where it’s located, and what the market looks like. Even in less-than-favorable market conditions, if you can check those other boxes, you can work to maximize this return.  

What are cash-on-cash returns like for other asset classes?  

With stocks, returns are only realized when you sell. The only cash-on-cash returns you get are dividends. On average, these dividends are only 1.85%. 

Plus, while stocks may have had an average annual return of 13.8% in the past few years, the long-term returns are lower, averaging 6.33%. 

This is evident in the last 2022/2023 decline. 

With Investream’s private investment opportunities, we underwrite and project 16-20% yearly total returns, which includes cash on cash plus total gain. Private offerings tend to be more efficient than REITs. For the past 12 years, REITs have seen about a 12.7% return, compared to the S&P 500 total annual return of 9.5%. Generally, private opportunities have less overhead, and therefore higher returns than REITs. 

What else should investors consider when choosing between asset classes?

It’s important when you’re investing to weigh all the benefits and drawbacks of different asset classes. Yes, returns are important. So is diversifying your portfolio. The stock market can be unpredictable, especially if you only invest in a few different companies. An economic downturn can undo much of the progress made from well-planned portfolios.  

Even in times of prosperity and good returns, investing in real estate can offer benefits that go beyond what you get from CoC returns. Understanding these benefits is key to making financially wise investment decisions. 

Depreciation  

Investors can recover the cost of their real estate investments over time through depreciation. How much you can deduct each year in depreciation is based on the number of years the IRS expects the property to last. This is also known as the useful life of the property. Multifamily properties can be depreciated over 27.5 years.  

Depreciation can be calculated by first determining the adjusted basis of the property, which is the original purchase price and value of the building plus improvements made, minus depreciation already taken. This adjusted basis is divided by the useful life years to get the allowance for annual depreciation.  

Say a rental property is purchased for $1,000,000 and you make $250,000 in improvements. The adjusted basis would be $1,250,000. The annual depreciation allowance with the useful life of 27.5 years would be at 3.636% per year. Keep in mind, this only includes the value of the building. The value of the land would also need to be subtracted.

On top of that and in most cases, depreciation can be accelerated for all non-building property like mechanical and electrical systems for example. These can be HVAC units, water heaters, appliances, plumbing and electrical fixtures to mention a few. Cost segregation studies allow depreciation years average for these items to be reduced to 5-7 years. With recent laws, most can be fully depreciated in Year 1 of investment resulting in significant tax deduction opportunities for investors.

Upside to Appreciation  

On the flipside of depreciation, appreciation of a property can also come with benefits for investors. Properties that appreciate over time also increase investor equity. The longer an investment property is held, the more likely it is to result in a higher return.  

When you invest in multifamily real estate in up-and-coming areas, for example, you can stand to benefit more from appreciation. An increased interest in the area, driving up demand for rental properties, makes investors more interested to invest in these types of properties driving value up. 

Improvements made to the property, both inside units and in common areas and increased amenities, lead to higher income opportunities which forces appreciation even further.

Understanding the market and adding value to properties can work as a powerful combination to bring more value to investors. While appreciation isn’t guaranteed, it is more likely to occur with asset managers who are strong operators and have a deep understanding of the market and the properties they buy.

Natural Hedge Against Inflation  

Inflation in 2022 and 2023 has impacted many different areas of everyday life. The conversation often revolves around gas prices, the cost of eggs, and, of course, interest rates.  

The cost of living goes up with inflation, and rental property demand also tends to increase along with it. As people wait out stormy economic conditions, waiting for interest rates to return to normal levels to afford buying a house, they’ll be looking for temporary living situations, moving them toward more rental properties. Increased demand results in better occupancy rates and higher rents.

Multifamily properties also generate steady streams of income. With this and the increased demand during times of inflation, investors can expect rental income to outpace some of the effects of inflation on purchasing power.

In short, if all things seem equal when it comes to returns, or even if things seemed to be tipped in the favor of stocks in some years, consider all the benefits before deciding where to invest.  

Are you ready to start seeing cash-on-cash returns? Reach out to us and learn more about our properties and future investment opportunities.