Metrics That Matter - Part I


Originally Posted January 2019
Edited April 2024

Comparing IRR vs. Cash on Cash vs. Equity Multiple in Commercial Real Estate

When analyzing a commercial real estate investment opportunity, there are lots of numbers that may help guide investors to determine whether the projected property returns both meet the investor’s goals and are deemed by the investor to be an appropriate risk-adjusted return relative to other investments in the market. The following provides an overview of several of the top metrics that real estate investors may use to consider whether an investment is consistent with their investment goals and/or provides an appropriate projected risk-adjusted return. Of note, when presented with a prospective opportunity to investors for consideration, some metrics will be denoted as a “Target,” which simply means that the offering includes inputs, such as rents and expenses, that are speculative in nature and will rely upon the execution of a business plan in the future before being realized. There is no assurance that the actual performance of an investment will be consistent with any Target or projected metrics provided by the sponsor in their offering materials or calculated by an investor.

Part One: Asset Metrics

  1. Internal Rate of Return (IRR) The internal rate of return, or “IRR”, is the measure of an investment’s rate of return and is often called the discounted cash flow rate of return or “effective compounded return rate”.¹ It is the return of a property using a time value snapshot of inflows and outflows of capital over a projected period of time, also called the hold period. To break it down a bit further, consider that the investment is made as an outflow of money at the start, or time zero, and distributions are made by the property as inflows of money to the investors at times projected into the future over the hold period. Finally, upon sale an inflow of money (hopefully a profit if the asset is sold for more than the purchase price, fees and capital improvements).

    A financial calculator or Excel is used to calculate an estimated return of the project based on estimates of these inflows and outflows at projected periods of time. Of note, multiple IRRs can be estimated by changing the inputs used. And since time is a significant input that impacts the IRR, if nothing else changes but the hold period is shorter than originally projected, the IRR may increase, and if the hold period is lengthened the IRR may decrease, even if there is no actual change to a project’s performance.

  2. Cash on Cash (CoC) The Cash on Cash, or CoC, return is the ratio of annual before-tax cash flow to the total amount of cash invested, expressed as a percentage.² For example, if an investor invests $100,000 into a project and receives a distribution in year 2 of $5,000, then the cash on cash for that year is $5,000 / $100,000, or 5%. When a ‘Target Cash on Cash’ is presented for a particular transaction, it may be shown as the average of cash on cash ratios over the hold period term. For value add transactions, the property is likely to undergo some form of improvements during the early years of a hold period, and therefore may be expected to have lower cash on cash until the work on the property has been completed and rents can be increased.

  3. Equity Multiple (EM) The Equity Multiple is a multiple that reflects the total cash that an investor has put into an investment to the amount of cash that the investment has generated in full.³ For example, if an investor puts $100,000 into a property and receives $200,000 in total from distributions over the hold period and profit upon sale, this scenario would be reflected as a 2.0X equity multiple because $200,000 returned divided by $100,000 invested equals 2.0. The Equity Multiple differs from the Cash on Cash ratio due to the fact that the Equity Multiple is calculating cash flow and distributions over the entire hold period, whereas the Cash on Cash is only looking at cash flow on an annualized basis.

Example Comparison Matrix:

CRE Comparison Matrix

When looking at the three metrics – IRR, CoC and EM – to determine whether to invest in a particular real estate project, and to compare returns from one project to another, it is also important to review and consider the following factors: the time period the project is projected to be held, the market where the asset is being purchased (more core/metro markets have higher property values that are considered less risky, but may also have lower relative cash flow and therefore expected returns), the scope of work required by the business plan, the cost and terms of the senior debt on the property, the experience of the operator and ability to execute on the business plan, the project’s fees, risk factors that are specific to the project, the exit cap rate used for estimating the property’s target sale price, and the macro and micro economic factors that support the business plan as presented (i.e., estimated rent growth, estimated job growth, estimated income growth, the number of units under construction in the market or submarket that may impact supply).

Interested in learning about more metrics that matter? Click here to read Part II.

All information provided herein is for informational purposes only. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. Readers are recommended to consult with a financial adviser, attorney, accountant, and any other professional that can help you understand and assess the risks associated with any investment opportunity. Private investments are highly illiquid and are not suitable for all investors.

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