Question 1

How do you calculate a cash on cash return?

Accepted Answer

Cash-on-cash return (also commonly referred to as the “cash yield” of an investment) can be represented as a simple equation:  Cash-on-cash return = (Annual Dollar Income) / (Total Dollar Investment)

Question 2

What is cash on cash return used for?

Accepted Answer

This return metric provides a quick way to assess the magnitude of cash distributions throughout a project’s lifetime.

Question 3

How do you calculate equity multiple?

Accepted Answer

The Equity Multiple of an investment is a ratio used to help understand total cash return over the life of an investment. The ratio is equity to total net profit plus the total equity invested divided by the total equity invested.

Question 4

What is the equity multiple formula example?

Accepted Answer

Returning to our Groton, CT Multifamily example, you would calculate the target equity multiple for the minimum investment of $10,000 as: Equity Multiple = ($8,588 in cash distributions + $10,000 invested) / $10,000 invested = 1.86x Simply put, this equals “your money back, plus 86%.”

Question 5

What are disadvantages of using equity multiple?

Accepted Answer

While the equity multiple provides a nice snapshot of an investment’s overall profitability, it does not discount to present value. In other words, it does not account for how long the investor’s money is tied up, nor does it say anything about the distribution of cash flow throughout a project’s lifetime.

Question 6

What is Internal Rate of Return?

Accepted Answer

The internal rate of return (IRR for short) is the return metric most investors rely on for equity real estate investments. It is also the most complicated. The internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from the investment, across time periods, equal to zero.

Question 7

What does IRR tell you?

Accepted Answer

The internal rate of return (IRR for short) is the return metric most investors rely on for equity real estate investments. It is also the most complicated. The internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from the investment, across time periods, equal to zero.

Question 8

Is a high IRR good?

Accepted Answer

The higher the IRR, the more appealing the investment. As a discount rate, IRR accounts for the time an investor’s money is tied up in an investment; holding all else constant, the more time periods the investment comprises, the lower the IRR. The “time value of money” looms large for active investors, which is the main reason IRR is so prevalent in real estate investing.

Question 9

What are disadvantages of using IRR?

Accepted Answer

The main drawback of IRR is essentially the opposite of the equity multiple’s weakness. While it does incorporate time, it is not the best gauge of an investment’s overall profit potential. A very short project may show an outsized projected IRR despite low projected profit. The second drawback is akin to the equity multiple’s other weakness; the IRR alone also says little about the distribution of cash flow throughout a project.

Question 10

What metric should I look at for real estate investments?

Accepted Answer

No one return metric should be used in isolation as you evaluate the target or realized returns of an investment. Whether you are looking back at realized returns, or evaluating target return objectives, use all three metrics to arrive at a complete picture of investment performance. Examine how cash flow is expected to occur throughout the investment’s term, the underwriting assumptions, and all attendant risk factors.

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