Cash on Cash or (C/C) Return is a percentage that measures the return on cash invested in an income producing property. It is calculated by dividing before-tax cash flow (see cash flow model) by the amount of cash invested (down payment amount) and is expressed as a percentage.

                                Before Tax Cash Flow     =     % Return

                                   Initial Investment

The Cash on Cash Return is used to evaluate the profitability of income producing properties. It is an important analysis tool when comparing multiple income properties. The property with the largest cash on cash return generates the greatest return on each dollar invested. The cash on cash return calculation does however have some limitations.

Pros: Cash on cash takes into consideration vacancy and uncollected rents, operating expenses, and debt service.

Cons: Cash on cash does not go past a first year forecast and it does not take into account tax considerations or any increase or decrease in equity.

The Debt Coverage Ratio (DCR) is a widely used benchmark which measures an income producing property's ability to cover the monthly mortgage payments. The DCR is calculated by dividing the net operating income (NOI) by a property's annual debt service. Annual debt service equals the annual total of all interest and principal paid for all loans on a property. A debt coverage ratio of less than 1 indicates that the income generated by a property is insufficient to cover the mortgage payments and operating expenses.

                                      Net Operating Income (NOI)     =     DCR

                                       Annual Debt Service (ADS)

Many lending institutions require a minimum debt coverage ratio value to procure a loan for income producing properties. DCR requirements for lending institutions may vary from as low as 1.1 to as high as 1.35. From a lending institutions perspective, the higher the debt coverage ratio value, the more income there is available to cover the debt service which lessens the risk.

The Cash on Cash model and Debt Coverage Ratio are two methods used in examining a rental property's potential benefits, when buying property you should consult with real estate and tax professionals to ensure the validity of the analysis

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