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The market is changing rapidly, which means financial analysis and due diligence is increasingly important for multifamily investors. Metrics like cap rate, IRR, and cash-on-cash returns can be especially useful for investors comparing multiple properties and investment opportunities. These metrics offer a snapshot of a deal’s potential performance. This allows investors to filter deals and focus only on those that meet their specific investment criteria.

In this article, we delve into the realm of “cash on cash” returns. We cover how to calculate this metric, compare it to other financial metrics, it’s pros and cons, and ways multifamily investors can boost the CoC returns at their existing properties.

## What is Cash-on-Cash Return in Multifamily Investing?

Cash-on-cash return, often referred to as “CoC return”, is a financial metric. It evaluates the profitability of an apartment building in multifamily real estate investing. It measures the annual pre-tax cash income an investor receives from a multifamily property. This is relative to the cash initially invested in the property

## How to Calculate Cash-on-Cash Return for Multifamily Properties

The formula for calculating cash-on-cash return is as follows:

Cash-on-Cash Return = (Net Operating Income / Total Cash Invested) × 100

Net Operating Income (NOI) is the
income generated by the property
after deducting all operating expenses.

To calculate the individual components, understand the following:

1. Net Operating Income (NOI) is the income generated by the property after deducting all operating expenses, such as property management fees, property taxes, insurance, maintenance costs, and utilities. NOI is a key indicator of a property’s ability to generate income; and
2. Total Cash Invested includes not only the purchase price of the property but also any additional capital expenditures, closing costs, and financing costs (if debt is used to acquire the property).

The result is typically expressed as a percentage. A higher cash-on-cash return typically means a more favorable return on investment.

## Why Do Investors Use Cash-on-Cash Return?

Investors use the cash-on-cash return to assess the profitability of a real estate investment and to compare it to other deals and investment opportunities. It helps them determine if the property is generating enough income to cover their initial investment and provide a reasonable return (more on this to come).

Cash-on-cash return does not account
for the potential appreciation or depreciation
of the property’s value over time.

Importantly, cash-on-cash return does not account for the potential appreciation or depreciation of the property’s value over time. It focuses solely on the current income generated by the property relative to the initial investment.

## Example of Calculating Cash on Cash Return for Multifamily Property

Let’s walk through a simple example to see how we’d calculate the cash-on-cash return for an apartment building:

Assumptions for the Example:

• Purchase Price of Multifamily Property: \$1,000,000
• Down Payment: \$200,000
• Debt: \$800,000
• Annual NOI: \$80,000
• Additional Costs (e.g., closing costs, repairs, etc.): \$20,000
• Total Cash Invested: Down Payment + Additional Costs = \$200,000 + \$20,000 = \$220,000

Calculation:

1. Calculate the Annual Cash Flow:
• Annual Cash Flow = Annual Net Operating Income (NOI) – Annual Debt Service
• When financing is involved, calculate the Annual Debt Service (mortgage payments) as follows: suppose you have a 30-year mortgage with an annual interest rate of 4%. You can use a mortgage calculator or financial software to determine the annual mortgage payment. For this example, let’s assume it’s \$48,000.

Annual Cash Flow = \$80,000 (NOI) – \$48,000 (Annual Debt Service) = \$32,000

1. Calculate Cash-on-Cash Return:

Cash-on-Cash Return = (Annual Cash Flow / Total Cash Invested) × 100
Cash-on-Cash Return = (\$32,000 / \$220,000) × 100 = 14.55%

So, in this example, the cash-on-cash return for the multifamily property is approximately 14.55%. This means that for the initial cash investment of \$220,000, you are receiving a 14.55% annual return from the property’s cash flow, not accounting for property appreciation or other potential factors.

Below, we’ll look at whether 14.55% is considered a “good” cash on cash return.

## The Pros and Cons of Using CoC Return as a Financial Metric

Using cash-on-cash return (CoC return) as an investment metric in multifamily real estate can be valuable, but it has some limitations. Here are some of its advantages and disadvantages:

### Pros:

• Simplicity: CoC return is a straightforward and easy to calculate metric. It provides a clear percentage that investors can use to quickly compare different investment opportunities.
• Focus on Cash Flow: CoC return emphasizes the cash flow generated by the property. This is particularly important in multifamily real estate, where rental income is the primary source of revenue. It helps investors understand how much income the property is likely to produce relative to their initial investment.
• Initial Investment Assessment: CoC return is especially useful for investors who want to know how quickly they can recover their initial cash investment through property income. This is useful for investors who want to recover their initial investment over a short window, say 1-3 years. Investors with more patient capital may be willing to recover their initial investment over a longer time horizon.
• Risk Assessment: It can help investors assess the risk associated with an investment. Higher CoC returns often come with higher risk levels, though this varies from deal to deal. It depends on the property’s operations and expenses.

### Cons:

• Limited Scope: CoC return focuses solely on the cash flow aspect of the investment. It doesn’t account for potential property appreciation, tax benefits, or other factors that can affect the overall return on investment. In some instances, investors may find tax benefits more lucrative than the actual Coc return. Therefore, they might invest despite relatively low CoC returns.
• Impact of Financing Varies: CoC return does not account for the impact of financing (e.g., a mortgage) on the investment. Investors using different financing strategies may have varying CoC returns for the same property. This is especially true in a high interest rate environment, like we’re in today. Moreover, boosting CoC returns often requires greater leverage, meaning investors put in less capital up acquisition. This can make a deal riskier, even if it increases the CoC return.
• Short-Term Perspective: CoC return may encourage a short-term investment mindset. Investors may prioritize properties that offer high immediate returns, potentially overlooking long-term growth opportunities.
• Variability: CoC return can vary from year to year based on factors like occupancy rates, expenses, and rental income. It may not provide a stable, predictable measure of investment performance.
• Not Suitable for All Properties: Multifamily properties with significant capital improvements, value-add potential, or properties in markets with high appreciation potential may not be accurately represented by CoC return alone.

As you can see, while cash-on-cash return is a useful tool for evaluating the income-producing potential of multifamily real estate investments and can be a valuable part of an investor’s analysis, it should not be the sole metric used. Most investors will consider it in conjunction with other metrics, like cap rate and IRR, to get a comprehensive view of the investment’s potential.

## How Does Cash-on-Cash Return Compare to Other Metrics?

Cash-on-cash return is one of several financial metrics used to evaluate multifamily real estate investments. Other metrics can be utilized to provide a more comprehensive view of an investment’s potential profitability—though each of these also has its own strengths and weaknesses.

Cash-on-cash return is a
straight forward and easy-to-calculate metric.

Here’s a comparison of CoC return to other financial metrics like Internal Rate of Return (IRR), Capitalization Rate (Cap Rate), and Return on Investment (ROI):

• Cash-on-Cash Return (CoC Return): As noted above, CoC is used to determine how much income is generated relative to the initial cash investment. It is a simple metric that helps investors understand how quickly they can recover their initial investment through property income. However, it does not account for the time value of money, property appreciation, or tax implications.
• Internal Rate of Return (IRR): IRR takes into account the time value of money and provides a rate of return that considers both cash inflows and outflows over the life of the investment. It reflects the annualized rate of return on the investment. The benefit of using IRR is that it accounts for the timing of cash flows and is a more comprehensive tool for evaluating the overall performance of an investment. However, it’s complicated to calculate and requires investors to make assumptions about the property’s future performance and value upon exit. Moreover, it does not provide a clear measure of short-term cash flow.
• Capitalization Rate (Cap Rate): Cap rate measures the relationship between a property’s annual net operating income (NOI) and its current market value. It is a simple metric that helps assess the income potential of a property without considering financing. The benefit is that it allows investors to make quick property comparisons when trying to evaluate income potential. However, it does not factor in financing which can dramatically impact a multifamily property’s return potential.
• Return on Investment (ROI): People often use CoC return and ROI interchangeably, but these are indeed different metrics. ROI is a broader metric that calculates the overall return on investment, considering both cash flow and changes in property value over time. It provides a comprehensive view of the investment’s profitability, but it is often more complex to calculate and does not provide a clear separation of cash flow and property appreciation.

In practice, multifamily real estate investors will typically use a combination of these metrics when evaluating individual properties, portfolios of properties, and the business strategies related to each.

## What’s Considered a Good Cash on Cash Return?

What constitutes a «good» cash-on-cash return (CoC return) for multifamily investments can vary depending on several factors, including location, market conditions, investor goals, and risk tolerance. One investor’s idea of a good COC return may differ from another’s. Generally, a good CoC return for multifamily investments falls within the range of 8% to 12%. However, it’s essential to keep the following considerations in mind:

• Local Market Factors: CoC returns can vary significantly from one real estate market to another. In some high-demand markets, it may be more challenging to find properties with CoC returns at the upper end of the range, while properties in less competitive markets may offer higher returns.
• Risk Tolerance: A person’s risk tolerance plays a significant role in what they consider a good CoC return. Some investors may prioritize higher returns, even if it means taking on more risk, while others may prioritize stability and lower risk, accepting a lower CoC return.
• Financing and Leverage: The amount of leverage (e.g., mortgage financing) used in the investment affects CoC returns. Higher leverage can magnify returns if the property performs well, but it also increases risk if the property underperforms the business plan expectations.
• Investment Goals: Someone’s investment objectives – such as short-term income, long-term appreciation, or a balance of both – will influence what they consider a good CoC return on multifamily real estate. Someone looking for steady income might prefer a higher CoC return, whereas someone investing on the premise of long-term property appreciation may be willing to accept a lower CoC return.
• Property Condition and Business Strategy: Properties that require significant renovations or value-add strategies may have lower initial CoC returns but the potential for higher returns in the future as the property’s value appreciates.
• Interest Rates: Prevailing interest rates impact the cost of financing and, therefore, influence what investors consider a good CoC return. For example, in a high interest rate environment where someone can earn 5-6% returns in a risk-free U.S. Treasury bond, investors may be looking for double-digit CoC returns on multifamily investments. The correlation between current interest and what investors consider a palatable CoC return typically dictates that an acceptable spread is at least a few hundred basis points between the two.

While investors may have considered 8-12% a «good» cash-on-cash return over the past 10-15 years, rising interest rates might increase the CoC return threshold for many. Most investors will look at what they can earn on other investments and will weigh this against the risk and liquidity of those investments. In short, interest rates and broader market conditions play a significant role in defining what constitutes a «good» CoC return, turning it into a moving target.

## Ways to Increase the CoC Returns on Multifamily Properties

Increasing the cash-on-cash return (CoC return) of a multifamily property involves improving the property’s income and reducing its expenses, while potentially leveraging your investment more effectively. Here are some strategies for increasing a property’s CoC returns:

1. Increase Rental Income:
• Review the local rental market and, if justified, increase rents to match market rates.
• Adding desirable amenities – such as a fitness center, updated kitchens and baths, or in-unit laundry – can usually command higher rents.
• Allowing pets, while charging pet fees or rent, is another way to boost rental income.
• Consider allowing short-term rentals at your properties. In certain markets, offering units as short-term rentals on platforms like Airbnb can yield higher rents, but this strategy may come with more management and turnover.
1. Reduce Vacancy Rates:
• Improve marketing and advertising efforts to attract and retain tenants.
• Focus on lease renewals. Encourage existing tenants to renew their leases by offering incentives, such as rent discounts or upgrades.
1. Operational Efficiency:
• Consider professional property management to streamline operations and reduce vacancy rates. If you’re already using a third-party property manager, be sure to reevaluate their contract to ensure you’re not paying above market rate for the services being provided.
• Implement energy-saving measures to lower utility costs. President Biden’s Inflation Reduction Act offers several tax credits and other incentives for property owners willing to make sustainability upgrades to their properties.
• Hone in on preventative maintenance, as regular maintenance can reduce long-term repair costs and keep tenants satisfied.
• Strategically assess whether renovations and upgrades can warrant substantially higher rents. This may include kitchen and bathroom upgrades, flooring, exterior improvements, or the addition of new building amenities.
• If feasible, consider adding more units to the property, which can increase rental income.
1. Financing and Leverage:
• If interest rates have dropped significantly or the property’s value has increased, consider refinancing to reduce financing costs. Note: anyone who has refinanced in the past 5 years will likely have a lower interest rate than what’s available today; nevertheless, it’s important for all owners to monitor the capital markets to determine whether they can secure more competitive financing as market conditions change.
• Increasing your mortgage amount or using other financing methods can amplify your CoC return if the property’s income can support the debt.
1. Expense Reduction:
• Continuously evaluate and minimize operating expenses, such as property management fees, maintenance costs, and utilities. Many multifamily investors will look to implement RUBS systems that help pass the costs of utilities on to their tenants.
• Explore opportunities to reduce property taxes and other taxes associated with the property.
1. Risk Mitigation:
• Ensure you have comprehensive insurance coverage to protect against unexpected losses.
• Plan for contingencies, such as unexpected repairs, to avoid large, unplanned expenses.

Remember that increasing CoC return often involves a balance between risk and reward. High returns may come with higher risks, such as aggressive property appreciation assumptions or significant renovations. Be sure to conduct a thorough analysis and carefully consider your investment goals and risk tolerance when implementing these strategies.

## Conclusion

CoC return plays a pivotal role in aligning multifamily investments with investors’ objectives, whether it be immediate income, long-term appreciation, or a balance of both. Investors use it as part of a suite of financial metrics to comprehensively evaluate the potential and performance of multifamily properties. By considering CoC return alongside other relevant factors, investors can form a more complete understanding of the investment’s viability and its alignment with their investment goals.

## FAQ

#### What is the significance of cash-on-cash return in real estate investment?

Cash-on-cash return is crucial because it measures the annual return an investor makes on the property in relation to the amount of money invested. This metric is significant for evaluating the cash flow from rental income, helping investors understand how their investment performs on a cash basis, independent of real estate appreciation.

#### How does cash-on-cash return differ from cap rate and IRR?

Cash-on-cash return specifically measures the return on the actual cash invested, focusing on the income aspect of an investment. In contrast, the capitalization rate (cap rate) measures the return on the total purchase price of the property, regardless of how much cash was initially invested. Internal Rate of Return (IRR) considers the time value of money, providing a more comprehensive view by accounting for all cash flows and the sale of the property over the investment period.

#### Can cash-on-cash return change over time, and what factors influence it?

Yes, cash-on-cash return can vary from year to year due to changes in net operating income (NOI), financing costs, or additional capital investments. Factors such as occupancy rates, rental income adjustments, operational efficiencies, and refinancing can influence the cash-on-cash return.

#### Why doesn't cash-on-cash return account for property appreciation?

Cash-on-cash return focuses solely on the cash flow generated by the property relative to the initial investment, not taking into account the potential appreciation or depreciation of the property’s value. This metric is designed to provide investors with a clear understanding of the income-producing capability of the property, independent of market value changes.

#### What is considered a 'good' cash-on-cash return for multifamily properties?

A ‘good’ cash-on-cash return varies depending on market conditions, location, risk tolerance, and investor goals. Historically, returns in the range of 8% to 12% have been considered attractive for multifamily investments, but this benchmark can shift based on economic factors, interest rates, and individual investment strategies.

#### How can investors improve the cash-on-cash return of their multifamily properties?

Investors can enhance the cash-on-cash return by increasing rental income (through rent adjustments or adding value to the property to justify higher rents), reducing operating expenses, improving operational efficiencies, refinancing to better loan terms, or optimizing the property’s occupancy rate.

Última edición el marzo 25, 2024
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