Key takeaways
- Cash-on-cash measures one year of cash flow against equity. IRR measures the whole hold, including the sale. Equity multiple measures total dollars back per dollar in.
- In the example, a 5.2% year-one cash-on-cash return becomes a 12.9% IRR, but only if the property sells at the same cap rate it was bought at.
- Sell one point higher on the cap rate and the IRR drops to 6.6%. The exit assumption drives the answer.
Three measures, three questions
| Measure | Formula | Question it answers |
|---|---|---|
| Cash-on-cash | Annual cash flow after debt service ÷ equity invested | What does my equity earn this year? |
| IRR | The discount rate that sets the net present value of all cash flows to zero | What annual return did the whole investment produce, accounting for timing? |
| Equity multiple | Total cash returned ÷ equity invested | How many dollars came back for each dollar in? |
A five-year example
Purchase price $1,000,000 at a 7.5% cap rate ($75,000 NOI). Loan of $700,000 at 7.00%, 25-year amortization. Equity $300,000 (closing costs ignored for simplicity). NOI grows 2% a year. Sale at the end of year five at a 7.5% cap rate on year-six NOI, with 3% selling costs.
| Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
|---|---|---|---|---|---|---|
| NOI | $75,000 | $76,500 | $78,030 | $79,591 | $81,182 | |
| Debt service | ($59,369) | ($59,369) | ($59,369) | ($59,369) | ($59,369) | |
| Cash flow | ($300,000) | $15,631 | $17,131 | $18,661 | $20,221 | $21,813 |
| Net sale proceeds | $432,823 | |||||
| Total | ($300,000) | $15,631 | $17,131 | $18,661 | $20,221 | $454,636 |
Illustrative example. Hypothetical numbers chosen to show the math. Your property's numbers will differ.
- Year-one cash-on-cash: $15,631 ÷ $300,000 = 5.2%
- DSCR year one: $75,000 ÷ $59,369 = 1.26x
- IRR: about 12.9%
- Equity multiple: $526,279 returned ÷ $300,000 = 1.75x
Sale price is $82,806 of year-six NOI ÷ 7.5% = $1,104,081. Net proceeds subtract 3% selling costs and the remaining loan balance of about $638,135.
The exit cap rate decides the answer
| Exit cap rate | Sale price | IRR | Equity multiple |
|---|---|---|---|
| 7.0% | $1,182,944 | 16.2% | 2.01x |
| 7.5% | $1,104,081 | 12.9% | 1.75x |
| 8.0% | $1,035,076 | 9.8% | 1.53x |
| 8.5% | $974,189 | 6.6% | 1.33x |
Illustrative example. Hypothetical numbers chosen to show the math. Your property's numbers will differ.
Most of the return in a five-year hold comes from the sale. That makes the exit cap rate the most important assumption in the model, and the easiest one to shade. Test it at least half a point to a full point higher than the going-in rate.
Where each measure misleads
- Cash-on-cash ignores the sale and loan paydown. A low number can still be a good investment, and a high one can hide a weak exit.
- IRR rewards speed. A quick sale with a modest profit can show a high IRR on few dollars.
- Equity multiple ignores time. A 2.0x over three years and a 2.0x over twelve are very different results.
Use all three, alongside DSCR to check the debt and cap rate to check the price.
Common questions
What is a good cash-on-cash return?
It depends on the property, the leverage, and the alternatives available to you. Compare it to the property's risk and to what the same equity could earn elsewhere, and look at the full-hold IRR before deciding.
Why is my IRR so sensitive to the sale price?
In a typical five-year hold, the sale returns most of the equity and profit. Small changes in the exit cap rate change the sale price, and the IRR moves with it.
Should I use levered or unlevered IRR?
Both. Unlevered IRR shows how the property performs on its own. Levered IRR shows what your equity earns with the loan. In this example, the unlevered IRR at a 7.5% exit is about 9.0%.
General information, not legal, tax, accounting, or investment advice. Examples marked illustrative use hypothetical numbers.