First, a reminder that this blog site is aimed more for those who are new to the real estate development industry or who are interested in learning more about it. Consequently, some of the postings, but not all, will be geared specifically for that audience. This is one of those postings.
Developers, whether newbies or old pros, have to raise the capital required to make the investment in the proposed project. In the current market, debt provides, at best, about 60% to 70% of the development capital needed. The balance generally is raised in the form of equity - money invested by individuals or entities with the expectation of profit or return of, as well as on, the investment. These are financial partners, not lenders.
While there are a number of ways to measure that return on investment - some more sophisticated than others, a classic method is what is called cash-on-cash. It means literally: cash returned on cash invested. It is calculated by dividing the amount of cash returned to an investor in a given year by the total amount of equity invested by that investor to date. The result is expressed as a percentage.
For example, if an investor contributes $100,000 to the project and receives $7,500 during the first year of operations, the cash-on-cash return would be measured as: $7,500/$100,000 or 7.5%.
One of the major flaws in this method is obvious. Investment in real estate projects is a long-term or multi-year proposition; whereas, the cash-on-cash method only expresses return on investment for a single year. Nevertheless, it continues to enjoy widespread usage.
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