There are a number of terms and concepts that you should get familiar with if you're seriously considering investing in multifamily syndications. For starters, you should understand how to both calculate and evaluate the prospective return on your investment. When evaluating multifamily investment opportunities, the two most common metrics that investors use are Cash-on-Cash Return and Internal Rate of Return. Let’s look at each metric in more detail.
Cash-on-Cash return, or simply CoC, is calculated by dividing the annual cash flow of the property by the initial investment. Because cash flow fluctuates from one year to the next, the CoC percentage is typically different during each year of the investment term. To get an overall picture, we can take an average of these yearly numbers to come up with an Average Cash-on-Cash Return. CoC does not factor in the sale proceeds at the end of the investment term.
Here is an example:
In this example, the cash flow divided by the initial investment determines the cash-on-cash return. An investor typically utilizes this metric to determine their yearly return on investment.
Although it uses similar inputs as Cash-on-Cash Return, Internal Rate of Return (IRR) is a lot more complex to calculate as its formula accounts for the time value of money. The further into the future the cash distribution is expected to occur, the lower the IRR becomes. You can calculate IRR using the built-in IRR() function in Excel or with this web calculator, which we used for our example below.
In this example, the IRR is determined by discounting the future cashflows down to a Net Present Value to determine the true rate of return throughout the entire hold period. An investor typically utilizes this metric to measure the speed of their cash flows when taking into account time value of money.
Which one should you choose?
Choosing one or the other depends on your investment goals and objectives. An investor who is more focused on yearly cash flow across a long hold period of over 7-10 years may focus more on cash-on-cash return to gauge what their return on investment would be yearly. An investor who is more focused on receiving their invested capital back as quickly as possible within a shorter 5 year hold period may evaluate IRR because it takes into account time value of money.
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