CPI Blog

What is a Cash-on-Cash Return in Real Estate Private Equity (Syndications)?

by | Apr 2, 2022

There are a variety of metrics in use which REPE investors use to measure investment performance or profitability of a particular transaction.

Some of the more well-known ones include IRR (“Internal Rate of Return”) or RoI (“Return on Investment”) but cash-on-cash (“CoC”) is also frequently used as a simple tool to help investors measure the profitability of multi-family or other investments.

What is a cash-on-cash return in REPE?

The calculation for a cash-on-cash return measures the net income produced by a property compared with the initial cash (equity) investment made to acquire such same property. The initial cash outlay may be mainly equity contributed by the investor, but it might also include certain expenses and some funds for upgrade or renovations.

CoC returns help when valuing property by calculating annual cash flow compared to the original cash invested and also factors in the impact of borrowed funds. The results of the can help determine an overall RoI over time and the result of the cash-on-cash calculation is often referred to as the “cash yield” or even “Return on Equity (“RoE”).

The CoC formula is one of the most utilized investor tools which help to screen an investment in commercial real estate where there is a longer-term debt commitment.

Why is the cash-on-cash return important?

CoC returns are used to help with assessing the potential profitability of a deal as they can indicate how an investment is expected to perform. Because cash-on-cash returns also take into account any debt commitment, they can also help investors choose between alternative financing methods. Such methods may be taking a loan from a traditional mortgage lender or via private lender sources.

By using CoC returns as a means of comparison, investors can use the metric to obtain a consistent basis for comparison of the long-term potential of different investment properties, and better understand how each one will impact the performance of their overall portfolios.

Assuming all other factors are equal, however, the cash-on-cash return of an investment in comparison to other similar projects will provide a reasonable indication of how projects compare to each because it also factors in management and operational costs to derive an NoI.

When is a cash-on-cash return used?

For those who regularly invest, a cash-on-cash return assessment will be one of the initial tools used when analyzing a potential deal. CoC can also help look at potential changes or fluctuations in future rentals, enabling investors to continually evaluate the performance of an investment.

Differentiating between RoI and CoC

Some investors tend to use the terms “Return on Investment” and “cash-on-cash” interchangeably, although, in reality, they are not the same. ROI looks at returns on the total investment, including loans which the purchaser took to finance the purchase, whereas CoC looks at returns relative to any cash spent out of pocket by reviewing ongoing current income relative to total amount invested at a given moment in time.

To explain further, the RoI looks at the entire cost of the investment and measures how much profit is made overall. It measures this against the time value of money to result in an IRR calculation or, put another way, the ROI measures the overall return of an investment and indicates the performance once a project has completed its life cycle.

The RoI can also be measured as an overall gross number relative to the original investment as a multiple of that investment, often called the “equity multiple”.

Both the RoI and cash-on-cash returns are useful tools to aid investors in the assessment of projects, but it’s important to note that they are in fact different tools!

Cash-on cash returns vs NOI

NoI is derived by deducting property operating expenses such as staff costs, utilities, repairs and maintenance costs from the total income a property generates on an annual basis.

What is considered to be a “good” cash-on-cash return?

There is no specific figure or set of figures which constitutes a “good” CoC return as this depends on many factors which can include the stage of the real estate cycle when the investment is made or returns compared to other projects in the same location. The investor’s risk-return priorities and investment objectives also need to be considered. In a growing market, or one where values are appreciating, investors may accept a lower return as there is growth expectation.

Having said the above, most investors expect a projected cash-on-cash return of between 8-12% to make an investment worthwhile, although 5-7% can be considered as acceptable in some markets.

In any event, it’s important to note that the CoC return rate will vary greatly based on how much is spent out-of-pocket and how the cash flow is structured.

Attractions of using a cash-on-cash return

Although the CoC return only reflects results based on the ongoing cash available for distribution from a project, and does not consider the appreciation of the property’s value overall, it is a simple formula which provides an indication of immediate returns, thereby providing insight into ongoing passive income and the current yield on an investment.

It is, therefore, a helpful metric for potential investors as it describes the current yield an investment is earning and, so demonstrates, the immediate income an investor can expect to receive.

It is particularly useful when investors or partners are concerned about consistent, positive cash flow.

Drawbacks of using a cash-on-cash return calculation

Even though the cash-on-cash return calculation is very simple, it relies on limited information and doesn’t, for example, consider exposure levels to debt, tax implications or property appreciation, a resale or future cash flow.

Obviously, therefore, even though the calculation may provide an overview and general indication of a property’s potential return, it shouldn’t be the only analytical tool used when making an investment decision.

The CoC calculation also does not account for the time value of money or compound interest.

How a risk return profile affects CoC returns

An investor’s risk return profile is another important consideration when determining what is an acceptable to good CoC return.

A new build or ground-up project, for example, is perceived to constitute a higher risk and will yield a zero cash-on-cash return during the construction and leasing-up phase of the project. However, once net cash flow turns positive, such returns may exceed those resulting from an existing, older project in the same area.

The risk-return profile also needs to be considered where the opportunity is a “value-add” apartment investment. Again, in the early stages of a renovation project as tenants move out, units are under renovation and rents beginning to increase, cash on cash returns will be considerably lower compared to when the building is fully renovated, rents are maximized, and vacancy rates lower.

Cash-on-cash returns vs real estate cycles

As a real estate cycle lengthens CoC returns will usually reduce. Such returns will be markedly higher in the early stages of an economic recovery, as rental and prices following an economic downturn are generally lower due to lack of liquidity in the market.

The perceived risk of real estate investment is higher, as investors are recovering from the difficult times. However, as the economy recovers, more investment funds will enter the market, pushing up prices and cash-on-cash returns will reduce. In addition, interest rates usually rise in the late-cycle, making debt service more expensive and further compressing CoC returns.

Furthermore, as the real estate cycle extends, any financial pain associated with the earlier downturn dissipates and investors become more willing to take on greater risk for lower cash-on-cash returns.

How to utilize leverage to enhance cash-on-cash returns

In order to acquire real estate investors, typically, use debt and equity. The equity is provided from the investor’s own savings and cash-on-cash returns only apply to this type of capital. Therefore, by utilizing leverage by taking a mortgage loan or debt, the CoC returns on equity can be increased.

How to calculate cash-on-cash returns

The formula for calculating cash on cash return is actually quite straightforward and is as follows:

Cash-on-cash Return = (Annual Cash Flow divided by the Initial Cash Outlay) x 100%

Obviously the annual cash flow needs to be calculated and this means working out the net rental which is left after all expenses have been paid.

Some typical recurring expenses which will need to be deducted from the gross revenues and will, therefore, impact calculations are:

  • Operating staff costs
  • Repair and maintenance costs
  • Cost of utilities such as water, electricity, gas etc
  • Property management fees
  • HOA or other community fees (if applicable)
  • Mortgage or loan repayments
  • Property taxes and insurance

Most times there will be an itemized operating budget showing both gross revenues and expenses, so these sorts of costs can be easily identified. Revenues from sources other than rentals can be included in the gross revenues, such sources including car parking fees, extras charges for air conditioning, extra cleaning or laundry services and so on.

Once expenses have been deducted from gross revenues to find the monthly income, this needs to be converted to the annual cash flow.

The next step is to calculate the initial cash investment or capital contributions made when acquiring the property. These may include the deposit or down payment, closing costs, and any improvements or repairs made to the property.

Once the annual cash flow and total cash outlay is known, apply the formula shown above to obtain a figure of 5, 10 or 15% whatever it is.

Yet it is worth repeating here that a cash-on-cash return is the investment return based on the initial capital or equity outlay by the investor, not the total outlay for the project.

That’s one reason it may also be called return on equity (“RoE”).

The cash-on-cash return formula not only allows investors to measure returns as a function of cash flow, but it can also help our team at CPI Capital decide if a potential deal is viable or even how much to put towards a deposit or down payment. In short, the CoC return analysis is a great way to get a quick snapshot of returns on investment.

Obviously we do use a variety of other, often more sophisticated, analytic tools and metrics to analyze and assess REPE deals. These include IRR, loan to value (“LTV”) ratio, analysis of capitalization rates, and so on.

As it is a widely accepted, common measurement in real estate deals, the cash-on-cash number can be helpful when communicating with shareholders or partners. The resulting CoC percentage is also helpful to see how operational costs are affecting returns but it won’t indicate how much the investment is making overall or give an indication as to the amount of risk involved.

Fortunately, we have the right experience with our teams to comprehensively analyze and cover all bases in any REPE deal, all for the benefits of our investors!


Yours sincerely

August Biniaz
CSO, COO, Co-Founder CPI Capital

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