What are the limitations of cash-on-cash return?

Cash-on-cash return measures one year of cash flow and nothing else. It ignores appreciation, loan paydown and tax benefits, which are often most of a rental's total return. It is only as honest as its expense assumptions, and it cannot compare deals with different holding periods or exit plans.

Because it excludes equity growth, a 6% cash return on a property appreciating 3% a year with a loan paying down $1,800 a year understates the total return, which is closer to 18% on the cash invested in year one.

Because it is a snapshot, it does not know that rents will rise or the roof is old. And leaving out vacancy, management or reserves can double the figure. Use it for screening and for judging whether you can hold the property. Use IRR or total return for decisions that span years.