ROI vs. ROE vs. Cash on Cash
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.