Cash on cash return is the most used metric to evaluate the cash flows of an income producing property, relative to the amount of cash invested (hence its name Cash-ON-Cash).
Cash on cash has 2 major drawbacks when used to evaluate an investment:
- It only considers the first year of the investment and ignores the holding period. This means regardless of the number of years a property is held as an investment, the cash on cash remains the same since it does not account for the benefits of inflation, discounts, depreciation, tax deferments, and capital reinvestments.
- Cash on cash doesn't account for the disposition of an asset that may carry greater unrealized gains as investment vehicles that are only realized upon the sale of the property.
For these 2 reasons, Cash on Cash is mostly used to forecast short-term returns on your invested capital, but never long-term returns. A much better long-term returns metric is IRR and Discounted Cash Flow Analysis. Without taking into account these additional cash flows that occur over the holding period, it’s impossible for the cash on cash return to accurately reflect the return characteristics of the property.