Rates of Return

Free-and-Clear Rate of Return

The free-and-clear rate of return measures the return potential of a property that is free of debt. This formula compares net operating income (NOI) with the total property value (purchase price). Free-and-clear return is also commonly known as return on investment (ROI) or overall rate. Owners look at this as a return, while the investor looks at this measurement as a capitalization rate. Although there are many types of return benchmarks used in property management, one of the more common ones measures the NOI as a percentage of the amount initially paid for the property. It is a similar measurement technique to cash-on-cash rate of return except that cash-on-cash uses BTCF divided by the initial investment (down payment). Both are measures of “return on investment,” but each is applied in a slightly different manner. ROI is commonly referred to as the free-and-clear rate of return because it does not take the cost of financing into account whereas cash-on-cash rate of return does.

NOI ÷ Value = Free-and-Clear Rate of Return

Cash-On-Cash Rate of Return 

Cash-on-cash rate of return ($/$%) measures the investor’s desired rate of return on an initial investment. This ratio compares the equity invested in a property (also called investment base) with the BTCF from one year. It is most commonly used to show year-to-year trends in performance. (Note: Cash-on-cash rate of return can also be called equity dividend rate or return on equity (ROE).)

The cash-on-cash return ($/$%) can be expressed in an equation that relates cash flow and initial equity (investment base):

BTCF ÷ Initial Equity = Cash-on-Cash Rate of Return ($/$%)

Initial equity invested includes the down payment and all acquisition costs that are not financed. The cash-on-cash rate of return measures a one-year return on invested dollars. It is snapshot of performance and thus does not consider the effects of time on the investment.