The Cash-On-Cash return is merely the profit earned from the cash invested in a deal. To state it more simply, it is the cash we make from our money. Here at Ridgeline, we focus on helping our clients have solid cash-on-cash returns. During these high-interest times, it is vital to have a solid cash-on-cash return on day 1.
How to Calculate Cash-on-Cash Return
Cash-on-cash Return = Pre-Tax Free Cash Flow / Total Capital Invested
First, let’s dig into how we calculate cash-on-cash. The calculation is relatively straightforward. We start by calculating the net yearly income after vacancy, loss to lease, concessions, and bad debt. We subtract all annual expenses such as insurance, taxes, debt, maintenance, management fees, utilities, payroll, etc. Next, we take that available cash flow for distribution and divide it by the money invested. Finally, we model this out for the years of the investment and get an average yearly cash-on-cash return, a metric significant to Ridgeline.
Why Cash-On-Cash is a Preferred Metric for Calculating Return
We prefer cash-on-cash because it’s one of the real estate industry’s most understandable and straightforward metrics. We also need to make fewer assumptions than, for example, with IRR. We only have to assume that we will have modest rent increases to the current market rents and slightly less expense growth. These assumptions are always based on past conservative historical performance.
Regarding IRR, you must assume an exit price five years or more into the future. We all know how much can happen in even a couple of years. For example, did we ever expect the rapid rate run-up in the last few years? To assume an exit price years down the road is an educated guess on what may happen in the future market. We like to be ready for the unexpected.
Strategy – Slow and Steady
We subscribe to the model that slow and steady wins the race. This is why the average yearly cash-on-cash metric most effectively affects these cash flow plays. It’s the most realistic way to assess an investment’s annual performance while keeping track of the rolling average cash-on-cash.
Wrapping it Up – Why Cash-on-Cash is the Winner
In conclusion, cash-on-cash is the winner for us. Our clients have cash flow goals they are trying to reach. Knowing the cash-on-cash return and the numbers behind it helps our investors quickly understand their trajectory toward those goals. It also allows our investors to achieve their goals and wishes without confusion. With cash-on-cash as a critical metric, we all realize a clear, concise, and straightforward way to evaluate a project’s success thus far and into the future.