When you own one or more rental properties, you naturally want to see a good return on your investment. If you don’t, then it’s probably time to sell it—and fast.
Calculating return on investment (ROI) for a rental property, though, doesn’t quite give you the whole picture. Instead, you should calculate your cash on cash return (CCR).
Your CCR, also referred to as the equity dividend return, is calculated a bit differently, according to Investopedia. “Calculations based on standard ROI take into account the total return on an investment. Cash-on-cash return, on the other hand, only measures the return on the actual cash invested, providing a more accurate analysis of the investment's performance.”
It looks like this:
Cash on Cash Return = Net Operating Income/Total Cash Investment
Your net operating income is the total amount of rent you collect, minus expenses on things like building maintenance, utility bills and property taxes. Keep in mind that all of this is calculated before income tax. Calculating your CCR can help you determine whether you need to take steps to improve your property and thus improve your CCR. First, let’s look at a quick example to help you see how CCR is calculated.
Let’s take a simplified scenario to illustrate how CCR is calculated.
You bought a property for $100,000 (and let’s assume that includes closing costs). You then spent another $50,000 on improvements so your total investment is $150,000.
Cash on Cash Return = Net Operating Income/$150,000
You sign some really great tenants and charge them $5,000 a month. After 12 months, you’ll collect $60,000, before taxes and expenses. Let’s say your expenses over those 12 months are $5,000. So your net operating income is $55,000.
Cash on Cash Return = $55,000/$150,000
Here’s your result:
36% = $55,000/$150,000
Of course, this is an over-simplified scenario that assumes you paid cash for your property and all improvements. If you took out a mortgage, you’d have to consider the original mortgage amount, the remaining balance and the mortgage rate. You’d also have to consider the value of the property now and in the future.
To avoid the headache of all that math, check out this very handy cash on cash return calculator.
Unfortunately, experts don’t really agree on what exactly a good CCR is. Some say 8 percent, while others insist on nothing less than 20 percent. No matter what the number, if you’re not comfortable with your CCR, there are ways you can improve it.
Look around your property. Are there simple improvements you could make to increase its value? Even a coat of paint goes a long way in making your rental more attractive.
If you have bigger projects to tackle—a new roof, a new furnace—it may reduce your CCR in the short term, but it should increase it in the long term. But don’t stop at the basics. Consider adding amenities that will attract and keep tenants.
Things like smart appliances or heated bathroom flooring could be a real draw. If you own a building with several units, think about adding bike storage, a small fitness area or a common room with table-top games to attract community-minded tenants who are willing to pay more for extra amenities.
Everyone knows keeping a tenant costs a lot less than finding a new one. Talk to tenants before they move in and gauge whether they’re looking for something long-term or if they just need a place for a year or less. Once you’ve found them, give them every reason to stay. Build a good, professional relationship, be attentive to their needs and keep the unit in good shape.
Get involved in your neighborhood and work to bring the kind of businesses and amenities that attract tenants. Do you have a run-down park with an old playground? Start or join a group to restore the park to appeal to families. Are there vacant storefronts? Partner with business associations on new events that can help bring attention to the unique qualities of the neighborhood.
Without realizing it, you may have gotten yourself into a bit of a tenant rut, attracting only a small part of the market. Think about how and where you advertise and how you can attract other segments of the tenant population that would see value in your units.
You could, for example, consider allowing pets if you don’t right now. While pets can damage apartments, you can ask for more rent to cover those potential costs. And since rentals that allow pets can be few and far between, most tenants are willing to pay a little more for a dog- or cat-friendly place.
The point is, the more value you add to your rental property, the more you can charge for rent. That, in turn, will increase your CCR. In the end, making your current tenants happy and offering value to future tenants will work wonders for your cash on cash return, and your investments.