The formula is one division; the useful part is seeing when the loan that is meant to lift the return pushes it down instead.
Cash-on-cash return is the year's pre-tax cash flow after debt service divided by the equity invested. On an illustrative $20,000,000 purchase financed with a 65 per cent, 5.50 per cent, 30-year amortising loan, $254,249 of cash flow on $7,400,000 of equity is a 3.44 per cent cash-on-cash return, lower than the 5.59 per cent the same building yields with no debt at all.
Worked in full in Private Equity Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
That second number is the reason to calculate it properly. Cash-on-cash is the measure most investors check first, and it is the one that most quickly shows whether the loan is helping. A loan whose annual debt service, as a percentage of the amount borrowed, exceeds the property's own cash yield lowers the return on every dollar of equity, however attractive the interest rate looks.
| Input | Value |
|---|---|
| Purchase price | 20,000,000 |
| Acquisition costs, 2% | 400,000 |
| Total cost | 20,400,000 |
| Net operating income (6.00% cap on price) | 1,200,000 |
| Capital reserve | 60,000 |
| Loan: 65% of price | 13,000,000 |
| Interest rate, monthly payments, 30-year amortisation | 5.50% |
Cash-on-cash = (NOI − reserves − debt service) ÷ equity invested
Loan constant = annual debt service ÷ loan amount
In Excel, annual debt service is =-PMT(5.5%/12, 360, 13000000)*12, which returns 885,751. Equity is total cost minus the loan, so acquisition costs sit in the denominator: they are cash the investor put in.
| Line | Amount |
|---|---|
| Net operating income | 1,200,000 |
| Less capital reserve | −60,000 |
| Cash flow before debt service | 1,140,000 |
| Less debt service (710,629 interest, 175,122 principal) | −885,751 |
| Cash flow after debt service | 254,249 |
| Equity: 20,400,000 − 13,000,000 | 7,400,000 |
| Cash-on-cash return | 3.44% |
The unlevered equivalent is 1,140,000 ÷ 20,400,000 = 5.59 per cent. The debt service coverage ratio, 1,200,000 ÷ 885,751 = 1.35x, is comfortable, so nothing on the lender's side flags the problem. The problem is the loan constant: 885,751 ÷ 13,000,000 = 6.81 per cent. Each borrowed dollar costs 6.81 cents a year in cash and the property it buys earns 5.59 cents. The 123 basis point gap is paid out of the equity's share.
| LTV | Equity | Amortising: cash flow | Amortising: CoC | Interest only: CoC |
|---|---|---|---|---|
| 0% | 20,400,000 | 1,140,000 | 5.59% | 5.59% |
| 30% | 14,400,000 | 731,192 | 5.08% | 5.62% |
| 50% | 10,400,000 | 458,653 | 4.41% | 5.67% |
| 65% | 7,400,000 | 254,249 | 3.44% | 5.74% |
| 75% | 5,400,000 | 117,980 | 2.18% | 5.83% |
With amortisation, every step up in leverage lowers cash-on-cash: 75 per cent debt leaves 2.18 per cent. Interest only, the constant is the 5.50 per cent rate itself, a whisker below the 5.59 per cent yield, so leverage nudges the return up, to 5.74 per cent at 65 per cent, but barely. The lever works in proportion to the spread between yield and constant, and here the spread is 9 basis points.
Where leverage turns neutral. Solve for the rate at which the loan constant equals the 5.59 per cent cash yield: 5.59 per cent interest only, but only 3.80 per cent on a 30-year amortising loan. Above those rates, more debt means less cash per dollar of equity.
| Interest rate | Loan constant | Cash-on-cash |
|---|---|---|
| 4.00% | 5.73% | 5.34% |
| 4.50% | 6.08% | 4.72% |
| 5.00% | 6.44% | 4.09% |
| 5.50% | 6.81% | 3.44% |
| 6.00% | 7.19% | 2.77% |
Even at 4.00 per cent, the amortising constant of 5.73 per cent is above the property yield, so cash-on-cash stays below the unlevered 5.59 per cent. Each 50 basis points on the rate costs roughly 65 basis points of cash-on-cash at this leverage.
The common mistake is to compare the cap rate with the interest rate, see 6.00 against 5.50, and conclude the leverage is positive. Two corrections reverse the verdict: the cap rate is on price, not on total cost after acquisition costs and reserves, and the cost of the loan in cash is the constant, not the rate. On cost and on constant the comparison is 5.59 against 6.81.
The second mistake is to read a low cash-on-cash as a bad deal. Amortisation is not a cost; it is equity being repaid. Adding back year-1 principal of 175,122 gives a 5.80 per cent return on equity before any change in value, and the total return still depends on growth and the exit, which is where leverage does its work, in both directions. Cash-on-cash is a measure of distributable income, not of the return.
Compute cash-on-cash on total equity, compare it with the unlevered cash yield, and compare the loan constant, not the rate, with that yield. On this deal the loan is safe but costs 123 basis points more than the property earns, so it lowers the year-1 cash return from 5.59 to 3.44 per cent. The free workbook for this case runs the same leverage ladder across the full range, and the loan sizing template shows the coverage side of the same loan.
It depends on the leverage and the loan terms, so compare it with the unlevered cash yield rather than with a rule of thumb. On an illustrative deal yielding 5.59 per cent unlevered, a 65 per cent amortising loan at 5.50 per cent gives 3.44 per cent; the same loan interest only gives 5.74 per cent. Leverage helps cash yield only when the loan constant is below the property yield.
No. Cash-on-cash counts only cash distributed, so amortisation reduces it even though principal repaid builds equity. On the illustrative loan, year-1 principal is $175,122; adding it back lifts the return on equity from 3.44 per cent to 5.80 per cent. Report both, and label which one you are showing.
Negative leverage is when debt lowers the cash return on equity because the loan constant, annual debt service over the loan, exceeds the property's unlevered cash yield. An illustrative 30-year loan at 5.50 per cent has a 6.81 per cent constant, 123 basis points above a 5.59 per cent yield, so every extra point of LTV reduces cash-on-cash.
This article is one calculation from Private Equity Real Estate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: real estate investing, finance and fund management → · All 453 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.