I have been trying to figure out how to size cash on cash returns and there are a few tricky parts I need help with.
1. Is reversionary cash flow from the sale factored into Cash on Cash?
2. When you refinance do you reset the amount of cash in the deal?
3. Is the cash in the deal constantly decreasing as you give distributions?
Thanks for your help!
Good question. Enterprising equity salesmen can mess around with the numbers and you are asking the right questions.
1) No, reversionary cash flow is not factored into CoC
2) Yes, reduce your equity balances post-refinance
3) No, operating cash distributions should not decrease your equity balances. Valuable to understand payback break-even, but it should not go into the CoC calc
I disagree with number 2. If you have capital partners, then the cash would likely(sometimes) go to paying back the accrued rate of return. That means it would be treated like your #3, with capital paid back to investsors not being counted.
I'd say the c-o-c is the deal level, and therefore you wouldn't count a refi, just like a reversion in your cash-on-cash because it is a capital event.
I hear you Shervin. We go back and forth on that all the time. My thought is this: assuming you are cashing out equity and not just refinancing at par, then your interest costs will be higher and operating cash flow lower post-refinance. This is not necessarily true but it's true in 80%+ of refis I've looked at. If you don't count the equity you pull out upon refi, then you are unnecessarily punishing your CoC post-refi, which on some deals can be the majority of your underwritten hold period.
Not really. Capital events affect the denominator, and operating cash flows affect (are) the numerator. Refi proceeds should reduce the denominator, just like capital calls should increase the denominator as opposed to reduce the numerator.
A question on cash-on-cash calculations:
It seems according to the above comments that operating cash flow is to be used as the numerator - where do you put leasing commissions, tenant improvement allowances, and capital repairs/replacements? Numerator or denominator?
I am less certain on this when I think of the property as being single tenant (the LCs / TIs would result in a large negative numerator and will be getting captured in the denominator) vs multi-tenant (the numerator may still be positive due to the recycling of NOI from other tenants to pay for these costs and no impact to the denominator as no equity will be required to pay for them).
Thanks in advance!
I usually put capital costs in the numerator if paid out of cash flow or holdbacks of cash flow from prior years. If we need an excess equity contribution/capital call on top of that, that contribution hits the denominator. If we have undrawn debt funds, drawing on them indirectly affects the numerator through increased interest costs.
Generally in our models, cash-on-cash looks better if it's treated as a cost requiring equity/debt funding, rather than reducing cash flow. But that isn't how we operate in practice, so while the approach above is more conservative, it's less likely to overstate the actual yield.
Got it, thanks!
Also curious, when people quote cash on cash (not specifying whether gross or net) are they referring to it before or after asset management fees? I feel like it makes more sense to include asset management fees (reduce numerator), but I find deals never hit target CoC unless these fees are omitted from the calc…
Am I just not finding great deals, or am I comparing apples to oranges?
I usually end up including them. How much does your yield decrease by? I just tested it on one of our models, and assuming no AM fee (1% of revenue) increased average cash yield by ~20bps over 10 years.
It drops CoC by ~150 bps depending on the year - which I guess makes sense if using 1.5% of average deployed equity for an asset management fee?
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