Cash-on-Cash - What denominator to use?


So assuming a property with GAV of 100m financed by 50 % bank loan and 20 % vendor note that runs for 3 years, meaning initial equity of 30m. How would you calculate cash-on-cash? I'm assuming cash flow / 30m for the first three years but how about year 4 and onwards? Just cash flow / 50m? How would you present the average cash-on-cash?

I find it a bit confusing as the vendor note is just a deferred equity investment, and if you just take the average of the yearly cash-on-cashes based on the method above you get a higher average then if the deal wasn't financed with a vendor note. If anything the interest rate on the vender note would reduce the cash you get back so I find it a bit misleading that the average cash-on-cash is higher in the case where you pay interest.

How are you guys looking at this? Curious to hear where my reasoning is wrong.



Comments (4)

pudding, what's your opinion? Comment below:

There is no correct answer. Some firms will do it over $30M as long as they hold it. Some firms will decrease the equity amount monthly based on cash flow to show an increasingly higher amount and therefore higher Cash on Cash. Some firms will only change the $30M denominator value only upon refi or a capital event. 

Regarding the vendor note, I'm not sure what that is. But it sounds like debt. Which in this case the denominator should be the initial equity amount - $30M. 

garyupper2, what's your opinion? Comment below:

Hi again,

Thanks for the response. A vendor note is just a form of financing from the seller to the buyer in terms of a loan, usually a short one. So the buyer would have to refinance in bank or add equity when the vendor note expires. Anyway, I have added an example below of what I mean. As you can see the average cash-on-cash is higher in the case including the vendor note as the first three cash flows are divided by a smaller denominator / equity. Is this average figure a correct representation though? More cash is returned to the buyer in the case without the vendor note / loan as you don't pay interest and you have to put in the same amount of equity, albeit at different times. The vendor note is really just a deferred equity investment to pump the IRR. Hope somebody can help me with this.




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pudding, what's your opinion? Comment below:

The vendor note is seller financing. Ok. So your equity is the initial equity in the deal.  When you refi the vendor note, if you need to put more equity in the deal, then your denominator changes. Otherwise it'll either stay the same or go down. My original answer still holds that there is no right or wrong way to do this. Just what makes sense to you. Someone might say always calculate your cash on cash based on initial equity. Others, as I stated above, might decrease the denominator monthly as cash comes in the door via rent payments, while others may only adjust the denominator upon capital transaction events (refi/sale/recap/etc.) Unfortunately not a clear cut answer. With that said, in my opinion, your "vendor note" is not equity or deferred equity. It's debt. If you assume you need equity to pay it off in a few years - well then sure you can look at it as equity. Again - it comes down to what you think is right. There isn't really a correct answer 

FreelancerCRE, what's your opinion? Comment below:

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windoflife, what's your opinion? Comment below:

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