How do you work out your cash-on-cash return for a property development? It sounds quite simple really. You put this much cash in, you take that much cash out as profit - a simple percentage. Which would make this a very short Property Pulse!
But wait! There's more!
You see, each deal's cash on cash return changes depending on the perspective you use.
Let's take a look at some deal figures as a starting point.
Purchase Price - $1m
Deposit: $200,000
Borrowings: $800,000
Project Running Costs - $100,000
Gross Realised Value (GRV) - $1.2m
Project Duration - 6 months
Profit - $100,000
In this deal, there's $300,000 of your funds required to cover the deposit and the project running costs.
You've made $100,000 profit, so if you divide the profit by total funds, you get a cash on cash return of 33.33%.
As I said at the start - simple, right? So what's all this nonsense about perspective?
Well, it all depends on where those funds came from. So the 33.33% could almost be called the "deal" perspective. But what other perspectives are there?
Money Partner
Think about this development deal from the perspective of using a money partner. Particularly if you found a money partner who's put in all of the required cash.
What's your cash on cash return? From your perspective, if you supplied $0 cash to the deal, then your return is infinite. That's a return I'm happy to take any day of the week!
From your money partner's perspective, the answer is different again. For them, they've put in the full $300,000 in costs, but they don't get the full 33.33% cash return.
In fact, their return will vary depending on the profit split you have in place. To keep it simple, let's choose 50/50 for the split. So their profit will be $50,000 for their cash of $300,000 - that's a cash on cash return of 16.67% for them.
Line of Credit
Hopefully you've kept up so far - because now I'm going to get a little funky and totally blow your mind!
Earlier when I talked about the deal's profit, I was talking about it from the perspective of cold, hard cash. Basically, money that was sitting in your bank account.
But what if you pulled that money from a line of credit? Now, it kind of looks like cash, and you've supplied it, not a money partner. What do you think your cash on cash return would be?
If you answered 33.33%, you'd be wrong. A line of credit is borrowed money, so in fact it's still not your money, so you've put none of your own money into the deal. Which takes you back to an infinite return, as we covered earlier.
But wait! I hear you cry. It's not that simple. You still have to have serviceability before you can get a line of credit. Plus you have to pay interest on the funds you use.
And both of those points are valid. Whether or not you have serviceability still won't change the fact that it's not your money, so your cash on cash return is still infinite.
The interest component, though, is a valid point. The money from your line of credit might be acting like cash, but it's going to cost you something to use it.
Now, unlike a money partner, it's not going to require you to give away a large slab of profit, but it's not entirely free, either. For the example I've used, if that line of credit is currently at 5%, then the interest would be $7,500 for six months.
Deduct that from the profit and you end up with $92,500. But here's the funky bit - although the profit has changed, you STILL have an infinite return on your cash! You still borrowed the money. Mind blown yet?
Timeframe
One final thing to consider - how hard is your money working? That's where timeframes come into the equation.
Let's say you have 2 development deals on the table. Both of them have a cash on cash return of 33.33%. One will take 6 months and the other 9 months. Which is the better deal?
If everything else is identical, then the best way to compare multiple property development deals is to annualise the return. That way, you can compare apples with apples.
In this instance, the deal taking six months is easy, you just double the cash on cash return and it's 66.66%. For the 9 month deal, though, the annualised return becomes 44.44%.
So if you want to make your money work as hard as possible for you, it makes more sense to do the 6 month development deal to get a return of 66.66%, rather than the 9 month deal for 44.44%.
Hopefully you now have a much better understanding of how to calculate cash on cash return, and how important it is to consider your perspective when you do.
But wait! There's more!
You see, each deal's cash on cash return changes depending on the perspective you use.
Let's take a look at some deal figures as a starting point.
Purchase Price - $1m
Deposit: $200,000
Borrowings: $800,000
Project Running Costs - $100,000
Gross Realised Value (GRV) - $1.2m
Project Duration - 6 months
Profit - $100,000
In this deal, there's $300,000 of your funds required to cover the deposit and the project running costs.
You've made $100,000 profit, so if you divide the profit by total funds, you get a cash on cash return of 33.33%.As I said at the start - simple, right? So what's all this nonsense about perspective?
Well, it all depends on where those funds came from. So the 33.33% could almost be called the "deal" perspective. But what other perspectives are there?
Money Partner
Think about this development deal from the perspective of using a money partner. Particularly if you found a money partner who's put in all of the required cash.
What's your cash on cash return? From your perspective, if you supplied $0 cash to the deal, then your return is infinite. That's a return I'm happy to take any day of the week!
From your money partner's perspective, the answer is different again. For them, they've put in the full $300,000 in costs, but they don't get the full 33.33% cash return.
In fact, their return will vary depending on the profit split you have in place. To keep it simple, let's choose 50/50 for the split. So their profit will be $50,000 for their cash of $300,000 - that's a cash on cash return of 16.67% for them.
Line of Credit
Hopefully you've kept up so far - because now I'm going to get a little funky and totally blow your mind!
Earlier when I talked about the deal's profit, I was talking about it from the perspective of cold, hard cash. Basically, money that was sitting in your bank account.
But what if you pulled that money from a line of credit? Now, it kind of looks like cash, and you've supplied it, not a money partner. What do you think your cash on cash return would be?
If you answered 33.33%, you'd be wrong. A line of credit is borrowed money, so in fact it's still not your money, so you've put none of your own money into the deal. Which takes you back to an infinite return, as we covered earlier.
But wait! I hear you cry. It's not that simple. You still have to have serviceability before you can get a line of credit. Plus you have to pay interest on the funds you use.
And both of those points are valid. Whether or not you have serviceability still won't change the fact that it's not your money, so your cash on cash return is still infinite.The interest component, though, is a valid point. The money from your line of credit might be acting like cash, but it's going to cost you something to use it.
Now, unlike a money partner, it's not going to require you to give away a large slab of profit, but it's not entirely free, either. For the example I've used, if that line of credit is currently at 5%, then the interest would be $7,500 for six months.
Deduct that from the profit and you end up with $92,500. But here's the funky bit - although the profit has changed, you STILL have an infinite return on your cash! You still borrowed the money. Mind blown yet?
Timeframe
One final thing to consider - how hard is your money working? That's where timeframes come into the equation.
Let's say you have 2 development deals on the table. Both of them have a cash on cash return of 33.33%. One will take 6 months and the other 9 months. Which is the better deal?
If everything else is identical, then the best way to compare multiple property development deals is to annualise the return. That way, you can compare apples with apples.
In this instance, the deal taking six months is easy, you just double the cash on cash return and it's 66.66%. For the 9 month deal, though, the annualised return becomes 44.44%.
So if you want to make your money work as hard as possible for you, it makes more sense to do the 6 month development deal to get a return of 66.66%, rather than the 9 month deal for 44.44%.
Hopefully you now have a much better understanding of how to calculate cash on cash return, and how important it is to consider your perspective when you do.
