Investment Fundamentals

Cash on Cash Return

4th October 2022

In the realm of commercial real estate investments, a widely used performance metric is the cash-on-cash return, also occasionally referred to as the cash yield. This metric offers a straightforward calculation achieved by dividing the annual pre-tax cash flow by the total cash invested. For instance, if an investor injects $100,000 in cash into the acquisition of an apartment building and receives an annual pre-tax cash flow of $10,000, their cash-on-cash return stands at 10%.

Here's the formula:

Cash-on-cash return = Annual pre-tax cash flow / Total cash invested

The cash-on-cash return primarily assesses operational cash flow, excluding any gains from capital events such as property sales or refinancing.

It's essential for investors to grasp that a forward-looking cash-on-cash return is a target, not a guarantee. In other words, it's not an obligation, unlike a coupon or debt payment, which must be met as scheduled, regardless of changes in the business plan or unforeseen circumstances. Consequently, investors should exercise caution when equating a targeted cash-on-cash return to a debt coupon, as the actual cash-on-cash return may surpass or fall short of the target figure.

Despite being a target-based metric, the cash-on-cash return holds significant value in estimating the potential distributions an investor may receive during the investment period. It distinguishes itself from the preferred return, an annual return priority that may or may not be met promptly and might not accurately represent the actual cash payouts in any given year.

Conclusion

The cash-on-cash return rate offers valuable insights into a property's business plan and the likelihood of consistent cash distributions throughout the investment horizon. In a forthcoming article, we will illustrate how pairing the cash-on-cash return with metrics like the Internal Rate of Return (IRR) and equity multiple can provide a quick understanding of a business plan and the potential distribution variations resulting from that plan.

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