How is cash-on-cash return different from average annual return?

If you have experience investing, it is likely that you know what cash-on-cash return is; you put “X” amount into a deal and you will receive a certain percentage back. When comparing the cash-on-cash return to the average annual return on a real estate investment, you may have noticed that annually, your average annual return is often times much higher than your cash-on-cash return. So, why are these numbers different from one another?

Cash-on-cash return and average annual return defined 
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‍To understand this difference, we break down what these two terms mean and how they are calculated. The average annual return is the overall return throughout the entirety of an investment averaged over the lifetime of the deal. It includes the annual cash flow produced as well as the proceeds from selling the investment at the end of the deal. Cash on cash return, on the other hand, refers to only the annual cash flow an investor receives from the investment each year.

For example, take an investment with a preferred return of 7% that is projected to have a lifetime of five years. The cash flow an investor receives from years 1-5 will fluctuate annually, but will most likely be somewhere around the preferred return rate. This number is their cash-on-cash return. Over the five years, if the operator is working their business plan successfully, the net operating income should be improving. Examples they may be using in their business plan may include renovations, raising rent, working on expenses, etc. This increases the property’s value when it is sold at the end of year five. To calculate the average annual return, we add the investor’s proceeds from the sale of the property as well as the cash flow received and divide it by the amount of years you’ve had the investment.

Why is this important to investors? 
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Why is it important to understand the difference between cash-on-cash return and average annual return? Essentially, there are two investment opportunities when investing in a real estate syndication- the cash-on-cash return and increasing the value of the property by increasing the net operating income. Therefore, finding a deal that not only provides annual cash flow but also has a solid business plan in place with the potential for a significant increase in property value can yield a higher average annual return. At Smart Wealth Equity, we do this for you.

Want to learn more about a different way to invest in real estate? Download our FREE Passive Investor's Guide to Multifamily Syndications and begin your path to financial freedom!