AAR vs. CoC: Which Metric Matters More for Your Investments?
When it comes to real estate investing, understanding the financial metrics that determine the profitability of an investment is crucial. Two of the most important metrics in this regard are the Average Annual Return (AAR) and Cash on Cash (CoC) return. While both provide insights into an investment’s profitability, they measure success in different ways.
Average Annual Return (AAR)
The Average Annual Return (AAR) measures the average annual profit that an investment generates over a specified period. This metric is particularly useful for evaluating the long-term performance of a real estate investment. It takes into account the total profit generated over the investment period and divides it by the number of years, giving you a percentage that represents the average annual profit.
Example:
If you invest $100,000 in a property and it generates a total profit of $50,000 over 5 years, the AAR is calculated as follows:
AAR = {{Total Profit}}{Number of Years} / {Initial Investment}
AAR = {50,000}{5} / 100,000 = 10%
This means that on average, the investment generated a 10% profit per year over the 5-year period.
Cash on Cash (CoC) Return
The Cash on Cash (CoC) return, on the other hand, measures the annual cash income earned on the cash invested in a property. This metric focuses solely on the cash flow aspect of the investment, ignoring appreciation and other non-cash benefits. CoC return is useful for assessing the immediate cash flow potential of a property and its ability to cover expenses.
Example:
If you invest $100,000 in a property and it generates an annual cash flow of $10,000, the CoC return is calculated as follows:
CoC = {Annual Cash Flow}{Initial Investment}
CoC = {10,000}{100,000} = 10%
This means that the investment generates a 10% return in cash flow each year based on the initial investment.
Combining AAR and CoC for a Holistic View
Both AAR and CoC return are valuable metrics, but they serve different purposes. AAR provides a comprehensive view of the long-term performance of an investment, including all forms of profit over the investment period. CoC return, however, offers insight into the annual cash income and the property’s ability to generate immediate returns.
For a holistic view of an investment’s profitability, it’s beneficial to combine both metrics. AAR helps you understand the overall profitability and growth potential of the investment, while CoC return allows you to assess the property’s cash flow performance and its ability to sustain itself financially.
Understanding and utilizing both Average Annual Return and Cash on Cash return can significantly enhance your real estate investment strategy. These metrics provide crucial insights into different aspects of an investment’s profitability, helping you make informed decisions.
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