What is a Cash-on-Cash Return?
A common metric for measuring commercial real estate investment performance is the cash-on-cash return, which is sometimes also referred to as the cash yield. The cash-on-cash return rate can provide useful insight into the business plan for a property and the likelihood of receiving regular cash distributions over the course of an investment.
A common metric for measuring commercial real estate investment performance is the cash-on-cash return, which is sometimes also referred to as the cash yield. It is a fairly simple calculation that is reached by dividing the annual pre-tax cash flow by the total cash invested. For example, if an investor puts $100,000 cash into the purchase of an apartment building and the annual pre-tax cash flow they receive is $10,000, then their cash-on-cash return is 10%.
Cash-on-cash return = annual pre-tax cash flow / total cash invested
The cash-on-cash return is typically a measure of operational cash flow and, therefore, excludes any profits realized from a capital event such as sale or refinance.
Although the cash-on-cash return may help to quantify cash distributions, one key point that investors need to recognize is that any forward-looking cash-on-cash return is not promised but targeted. In other words, it is not an obligation. In this way, the cash-on-cash return is different from a coupon or debt payment, which is a regularly scheduled payment that an operator must meet, despite changes in the business plan or eventualities. As a result, investors should be cautious to equate a targeted cash-on-cash return to a debt coupon. The actual cash-on-cash return may be higher or lower than the targeted number.
Even though it is a targeted metric, the cash-on-cash return is the most useful metric to estimate the distributions that an investor might receive over the course of the investment period. The cash-on-cash return is also distinct from the preferred return, which is an annual return priority that may or may not be paid current and may not reflect the actual cash to be paid out in any given year.
The cash-on-cash return rate can provide useful insight into the business plan for a property and the likelihood of receiving regular cash distributions over the course of an investment. In a future article, we will demonstrate how the cash-on-cash return can be paired with the IRR and equity multiple to get a quick understanding of a business plan and the distribution variations that may occur as a result of the business plan.
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