How do you think about the returns on your investments and what are your targets?

I look at my returns on this basis:

1. Cash on cash return. This is well-understood by most. I look at after-tax cash flow for a given year as a percentage of cash invested to purchase the property. I think of this as my “realized” return.

2. Principal paydown return. I’m not sure how other investors think about this. I look at the amount of loan principal paid down in an annual period as a percentage of cash invested to purchase the property. This is an “unrealized” return that can be realized upon refinancing. In order to realize this in the future, I assume the property value in the future will not increase (a conservative assumption over a long period of time in my markets historically). If rates increase in the future, it might cost me a higher interest rate upon refinance to realize this return, but I should be able to realize this. Clearly #1 above is more valuable to me than #2, so I give it more weighting.

3. Finally, I look at these two figures on a combined basis.

In my markets, for multi-family, I am targeting a high single digit cash on cash return and getting a mid-to-high teens “combined return”, as I think about it. I’m targeting properties that don’t have a need for improvements and are mostly optimized already. My returns include a professional property manager too.

How do others think about their returns and what are your current return targets?