REI School

Beware the Cash on Cash Return Formula

August 25, 2025 | 2 Minute Read

One of our core real estate strategies is balancing long-term rentals with short-term rentals. This mix diversifies our portfolio and has significantly increased our monthly net profits over the past several years.

But I don’t stop there—I’m always exploring new ways to boost cash flow. Recently, I started looking into the idea of using tiny homes as short-term rentals. My research began with YouTube videos, just to see if the strategy is viable before committing to anything.

The Reality of Tiny Homes

Here’s what I found: tiny homes ain’t cheap. Beyond the house itself, you need to buy the land, customization/design of the home, and have high-end amenities to attract paying guests who want that unique experience. Altogether, you’re likely looking at $100,000–$150,000 per unit.

Most videos on the topic focus on the type of tiny home, location, projected nightly rates, and occupancy targets. Then they hit you with the big hook—cash-on-cash return (COC). Many claim 25%–50% COC, which sounds incredible but is often misleading.

Understanding Cash-on-Cash Return

Here’s how COC is calculated:

  • Purchase price: $100,000

  • Down payment + closing costs: $25,000 invested cash

  • Annual net cash flow: $12,000

Formula:

$12,000 / $25,000 x 100 = 48% COC

A 48% ROI looks amazing on paper, and it’s easy to see why some investors would get excited. But the calculation often overlooks the real costs of operating a short-term rental.

The Real Expenses of Short-Term Rentals

Beyond your monthly PITI (principal, interest, taxes, insurance), STRs come with significant additional costs which you must cover:

  • Utilities (gas, electric, water)

  • Internet and cable

  • Furniture, décor, and amenities (initial cost spread across the first year)

  • Property management fees

  • Booking and pricing software, channel manager fees

  • Cleaning and housekeeping

  • Supplies (toiletries, paper goods, cleaning products)

  • Lawn care and garbage service

  • Routine and unexpected maintenance

For example, this month one of my STR properties needed:

  • $3,000 septic repair

  • $1,500 plumbing repair

  • $1,000 tree removal

That $5,500 bill will take me two months of bookings to recoup.

Across our STR portfolio, these operating costs average about 60% of gross income, leaving a 40% net margin. Still profitable, but far less glamorous than the inflated COC numbers often advertised.

A More Grounded Metric: Cap Rate

Instead of chasing COC hype, I prefer to evaluate deals with the cap rate formula:

Net income / Current Property Value

Example:

  • Gross monthly income: $2,500

  • Expenses: 60%

  • Net monthly income: $1,000 ($12,000 annually)

  • Current value: $100,000

$12,000 net / $100,000 = 12% cap rate

Now, if the property appreciates in two years to $110,000 and you increase your NOI to $15,000:

$15,000 net / $110,000 = 13.6% cap rate

Cash-on-cash return looks sexy and can be useful, but it’s often presented in a way that oversimplifies the reality of calculating returns on rental properties.

Cap rate provides a clearer, more realistic picture of long-term profitability.

In the end, you need to decide for yourself which ROI approach works best for you.

Exit mobile version