The cash on cash return metric is an important part of evaluating any multifamily real estate investment.
Hey, this is Devin Elder. I want to talk briefly today about understanding cash on cash return. I have a lot of conversations with investors and prospective investors that want to participate in one of our multi-family investment projects, and this is a big, important metric.
There’s a lot of jargon in the multi-family world, and you can get caught up in your N, excuse me, your NOI, or your gross rent multipliers, or your exit cap rates, and it’s good to understand all that stuff, for sure, but this is a metric that I like. It’s a very simple metric when you’re evaluating investment.
Cash on cash return. What does that mean? It means that if you invest $1 in a project, and in the first year that project pays you back 10 cents, that’s your return for year one, so in that year, you’re making a 10% cash on cash return. That means that your money, your dollar, is earning you 10% in that year. And this is a good metric, because we know right out of the gate, there’s some barometers.
If this return is 2 cents, there’s my 2 cents right there, and it’s a 2% return, that might not be very exciting. You might be able to put it in a CD for 1% or a little more, or you may be able to find another investment that is going to yield you 2% and be okay.
Now, there might be a project where the sponsor or the person putting the deal together is saying, “Look, it’s a big turnaround project, and we’re not going to do any distributions year one, because we’re going to spend a million bucks, and totally renovate this place, and then in subsequent years, in its sale, we’re going to see this big return.” So you have to look at globally, at the whole project, but cash on cash is a great metric to just quickly evaluate a project.
Now, on the other hand, if somebody shows you a project that is going to return you 25 cents year one on your dollar investment, that’s a 25% return in a year. If somebody showed me that investment, alarm bells would be going on, going, “Why is this investment so high?” This sounds risky, right? Return is a function of risk. Low returns, you’re going to typically expect low risk, so things like a CD or something like that. If I see crazy high returns on an investment, I’m going to start dig in a little further, and go, “Why is this return projected to be so high?”
So, the cash on cash return is what you’re making on your money in a given year on your investment. You invest a million dollars, and you get a hundred thousand back in that first year, that’s a 10% cash on cash return. So typically, in a multi-family project, you’re going to see, in general, 7 to 10% cash on cash returns, but also, you’re an equity investor in multi-family, so you’ve got to look at the whole project, and see what the path’s going to be on the back end.
Lots of things for you to consider as you’re looking at multi-family investments, but cash on cash return is one of my favorite metrics, because it’s just going to show you real quick, what is your money going to be earning on an annual basis versus other investment vehicles that you might be evaluating? You might be evaluating putting it in the stock market. You might be evaluating putting it into a single-family rental, which is a great investment for a relatively small amount of money. You might be looking at liquidating all your assets and putting it in the latest crypt o-currency, which I do not recommend, but somehow, people are doing that too.
Cash on cash, a good metric to look at when you are evaluating different investments. Hope that helps.