ROI vs. ROE vs. Cash on Cash

[Daniil Kleyman]

In talking to people and reading various posts online, I see a lot of confusion and varying opinions on ROI vs. ROE vs. IRR vs. Cash on Cash. For example, some people think that in the first year when you purchase the property, ROE (return on equity) and Cash on Cash are the same. The reasoning goes that your initial equity in the property before you see any appreciation or debt amortization will be equivalent to your cash investment, i.e. downpayment. While this can be close, at times, it almost never will be exactly the same. I can think of 2 reasons:

1) Not all of your cash investment into a deal will end up being equity. Your downpayment, yes, but not your closing cost (including points, legal fees, appraisal, etc). So your equity initially will be less than your total cash investment, leading your ROE to actually be higher than your cash-on-cash return.

2) If you are buying a property below market value, your equity from day 1 will be higher than your cash investment, leading your ROE to actually be lower than your cash-on-cash. The difference even in year 1 can be quite large.

Another thing I see quiet often is people differentiating between ROI and cash-on-cash return. I’ve seen all sorts of explanations. My take on it is that they’re basically the same. Cash-on-cash calculates your return on cash invested in to the deal. ROI (return on investment) can be calculated in many ways, but in my book it calculates the same thing â€" how much money am I earning on my cash invested into the deal. One deviation for ROI that I often encounter which makes sense to me is when figuring in the proceeds from resale of the property (this is when you monetize your amortization and appreciation and can calculate the $ benefit of both as a % of your original investment). I also call that calculation a “cumulative cash-on-cash returnâ€, which you can then annualize to get to a true return %.

I'd love to hear your opinions, especially differing ones.

[Bill Gulley]

Dan, you have some Enron accounting going on here.....you said your equity would be higher if you acquired a property at a discount or below market. That can not happen by definition, that thinking comes from TV gurus who lie.
The value of your property is what you paid for it, regarless of what your preceive the value to be. Now, after a year (in an new accounting period) your assets are valued at the LOWER OF COST OR MARKET, WHICH EVER IS LESS. Now, for mortgage financing, you use the current market value after one year, within a year, it's based on your cost.

As to analysis, look to the return on your cash as it may reflect a truer picture. In sub 2 or wraps, you may earn a return over the underlying loan under your contract. Such a deal requires a little weighted average analysis.

People who like to punch buttons on financial calculators like to look at ratios. From a financial aspect, most investors do not know what their real cost of capital is or what the over the hump rate is, or your opportunity costs, so you don't have a basis to compare to! It means nothing, it's just fun to do and it might bring a smile to your face, but from a financial business standpoint, meaningless. The same thing with a capitalization rate, you need to know what your cost of capital is and what alternative investment rates are before you can have an accurate rate. To keep a smile on your face, just look at how much cash you had to put into a deal and what you walk away with, much easier. Bill