Hi all,
Wanted to ask everyones thoughts on when computing the cash-on-cash return if you also include the amount of principal repaid that year to your actual cash flow? For example, a property is worth £1,000,000 and you get an 80% LTV, amortising over 30 years with say a 4% cost of debt which initially translates to a monthly payment of ~ £3,800 pcm (£45600/year and roughly £14,000 principal repayment). You fund 20% equity at £200,000. Let's say your yearly NOI is £50,000 (5% cap rate).
I have seen investors just compute the cash-on-cash return as (£50,000 - £45,600) / £200,000 = 2.2%, however I have also seen some include the principal repayment as part of their 'cash return' with a similar rationale as when computing FCFF we have to include the effect of share based compensation. This would make the deal more attractive at (£50,000 - £45,600 + £14,000) / £200,000 = 9.2%.
Any thoughts on the validity of this approach?
Thanks all!
I think it's an interesting metric and have seen it before, but definitely not in place of the standard CoC calculation - more as a supplement. That principal payment isn't cash that's readily available to you, so while its an interesting point to know it definitely doesn't replace the standard calculation, which is meant to tell you how much actual cash in hand you're getting relative to your cost basis.
CoC is a pretty flexible metric and you might see it calculated differently between firms. Hell, just google the calculation and you'll find three or four different methods advising differently on whether refi proceeds should be taken out of your denominator, whether you should add back principal, etc.
You either add the principal to your equity basis or count it as an expense on the CoC. You cant just ignore it.
I agree and this is how I have been working it out up to this point, however when I think of it like this I think this way holds some validity.
The principal you pay down in a year is equity that you have 'bought' in this property over this year. If say, at the end of that year you sell the property you would realise that years additional equity because you have less debt to pay off. What do you think?
Principal paydown is not included my cash on cash returns. It is included in my return on equity.
Agreed. CoC is probably better for short term analysis I assume and RoE better over the long term, or do you analyse both on yearly and over project length?
So, I have seen some calculate a "total return on equity" which is essentially... (NOI/Cashflow + Debt Paydown +/- Change in Value)/Initial Investment/Equity. This form of holding period return is sometimes useful for comparison purposes (note, for next year... you would reset "equity" by change in value and debt paydown most commonly, but that is stylistic approach).
"Cash on Cash" is literally meant to mean what it says.... (Cash Received)/(Cash Invested), thus adding debt paydown (def not cash you get), would literally violate the meaning of "cash on cash". Note, is the the "US" view, since you're quoting "Pound Sterling"... I'll note that stuff in UK/Europe is sometimes a bit "off" compared to US standard, so maybe this is some for of local convention?
BTW, this is why IRR/NPV is useful.... very very universal and hard to mess with! Everything else, can legit be subjective (personally I'd argue cash on cash literally explains what to do... but that's just me!)
Agreed it SOUNDS straightforward, but the most highly contested point I've seen between institutions in the metric is whether or not refinancing proceeds should reduce the denominator in the equation. I've seen models that hold the calculation steady based on peak capital invested over time, and others that will reduce it based on the cash they take out at refi.
I ALWAYS double check the calculation in other companies' models now because nobody seems to agree on a method.
I decrease my equity by any cash out refinances, I don’t see any case where you wouldn’t do that
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