After my talks at numerous networking events recently, I spoke with a number of investors who had been confused about my claim that a Cash on Cash Return of 15 per cent was achievable. In conversation, it became clear that I had not adequately explained the difference between Cash on Cash Return (CCR) and Yield.

Given that I consider CCR to be the single most important financial ratio in assessing a property deal, I think that I had better clear up any confusion.

Let’s look first at Yield.

What is Yield?

There are two types of yield for us to consider – gross yield and net yield.

Gross Yield is a simple ratio. The only things that matter are the income (rent) that a property will generate, and the purchase price of the property. Actually, things get more complex after a few years when the price of the property you paid is different to its current value, but for the moment, we will concentrate on the yield at time of purchase.

Let me give you an example of one of the properties that I recently purchased for a passive investor. We negotiated a 30% discount. The house was valued at £100,000 and our investor purchased it for £70,000. The rent is £575.

Gross Yield is simply the rent divided by the purchase price. Let us imagine the property let out with no voids. The annual rent is 12 * 575 = 6,900. So the yield is 6,900/ 70,000 = 9.85 per cent.

Net yield is slightly more complex. It takes into account expenses except from interest. So, to take the example further, the expenses might be:

§ letting agents commission of 10 per cent plus vat of the rent

§ insurance

§ CORGI certificate

§ maintenance

The rent for the year will therefore be 6,900

§ The agents commission would be 793 including VAT

§ Insurance might be 150

§ A CORGI certificate might cost 60

§ Maintenance might come to 350 over the year

So the total expenses related to letting the property are £1353.

Subtracting this from the rent gives a net income before interest charges of £5,547

The net yield is this net income divided by the purchase price, so £5547/ £70,000 = 7.92%

So, What is Cash on Cash Return?

Cash on Cash Return is a more complex figure, and takes into account how the deal is financed. The CCR measures the ratio between a property's anticipated first year's cash flow before tax to the amount of initial cash investment made by the property investor to purchase the rental property.

We look at the net cash flow, after interest payments, and divide that by the amount of CASH we put into the deal.

Sticking with our £70,000 house, let us assume that we are paying a deposit of 25 per cent = £17,500.

In addition we need to add in the other costs of buying the house, perhaps £900 and in legal fees and £350 valuation fee.

This means that we are putting £17,500 + £900 + £350 = £18,750 cash into the deal.

The fact we have put in a 25 per cent deposit means that we are borrowing 75 per cent of the purchase price. This comes out to a mortgage of £52,500, together with fees @ 2.5% = £53,812. Assuming that we borrowed this money at 5 per cent interest, we would be paying interest of £2,691 a year.

We subtract the £2,691 from the £5,547 which would leave you with £2,856 income at the end of the year.

We now divide the £2,856 by the cash you have put into this deal £18,750. This will give you a CCR return 15.23% return on your cash that you have left in the deal.

As a rule, however, cash-on-cash return is not considered a particularly powerful tool for measuring the profitability of rental income property because it doesn't take into account time value of money. In other words, because it doesn't compound or discount money over time, CCR is restricted to measuring an investment property's cash flow in the first year of ownership only. Nonetheless, the cash-on-cash return is not without validity. It will indeed provide anyone doing a property analysis a "quick read" comparison between investment opportunities and between similar income-producing properties.

If you are have access to fund the deposit without any of your own money, then you’re CCR would increase dramatically. Let me explain how?

The agreed purchase price is £70,000. The valuation price of the property is £100,000. If you are able to work with a funded deposit, you will draw down a 75% loan to value mortgage based on the valuation = £75,000 plus fees at 2.5% = £76,875.

There will be a funded deposit of £25,000 plus expenses as above – your solicitors £900 – and you may need to add in sellers solicitors costs too at £575. You will also need to account for the facility fee at £1,000 = £2,475. All in all, you will be looking for £27,475.

The complexities of the scheme result in £30k refund to the operators, who then deduct the £27,475, resulting in £2,525 being passed on to you. You will then need to deduct the valuation fee of £350 that you would have paid, and therefore your net amount is £2,175.

Your rent is £6,900. Your interest payments at 5% on £76,875 will be £3,843. Therefore your rent of £6,900 less £3,843 = £3,057. If you add on the £2,175, your cashflow for the first year will be £5,232, and you will have actually spent nothing on your acquisition.

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