Annualized returns are calculated by adding up “distributable cash” both from cash flow during the operation of your investment property and “equity” realized on eventual resale.
- Distributable cash from operations is the cash remaining after paying staff, operating expenses, debt service, and management, and after withholding sufficient cash for operating capital, reserves, and planned property improvements.
- Distributable cash from resale is determined after paying off the loan, any outstanding bills or obligations, then paying back the capital contributions of all investors (active and passive). After that, you will make up any arrearages owed to investors from prior cash flow returns.
- Add up all of the distributable cash generated from both cash flow and resale, and then divide it by the number of years you have owned the property, the result is the overall annualized cash generated by the property.
- If you then divide the annualized cash by the amount of cash invested to acquire and improve or develop the property (not including loans) and convert it to a percentage, you will have determined the “cash-on-cash” return for the property.
The target overall cash-on-cash return for a viable investment property is in the low to mid 20s (e.g., a 20% – 25% annualized ROI). In a syndicate or real estate fund, this overall return is then split between the active and passive members. The target return for passive investors is an annualized return in the mid to high teens, with the rest of the profits paid to the management team (i.e., active members).