Cash on Cash Return vs Cash Flow: What Few Investors Know

Most investors, even experienced ones, often think that cash flow is the excess money produced from the property and cash on cash return is cash flow divided by how much they invested.

Makes sense right?

It did to me for years before learning this.

There is one key difference and that is that cash flow also includes the distribution of cash reserves that were raised up front or stored in the deal.

For example, you might raise 6 months worth of expenses up front to be held in cash reserves.

Say in 2 years you've already implemented your value add plan, you've got long term fixed rate debt and the deal is cash flowing well. You might not need the full 6 months of expenses held in cash reserves. You might only need 3 months.

So what you can do is distribute half of the reserve balance back to investors and so they get a lump sum.

If you're only looking at cash flow metrics, it will show a high percentage of cash flow that doesn't directly reflect the performance of the asset itself.

Cash on cash return does not account for distribution of reserves. It will show you a more clear picture of how the asset itself is performing.