I am 9 months into the renovation of a multifamily building. I have invested significantly on capital improvement and hope to recoup some of that investment when I refinance later next year. I have then few questions on the following calculations:
- Cash on Cash: as much as you factor in capital improvements expenses, do you also consider cash out from a refinancing as impacting your cash on cash ratio?
- IRR: same question for the Internal Rate of Return - Do you factor in cash from refinancing in your IRR calculations?
In a more broader way: how does cash out refinancing impact your multifamily financial performance indicators?
Rental Property Investor · Southport, CT · Member since 2008 · 160 posts · 137 votes
7y
@Florent Breton The honor is mine, knowing someone actually reads my books and finds them helpful. Thanks. Feel free to ask me a question any time (preferably one I can answer).
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
7y
IRR: refinance is absolutely a factor in calculating IRR. This metric is designed to take any contribution or distribution into account.
Cash-on-Cash: form accounting standpoint, refinance reduces your cash in the deal, so future income constitutes a higher percentage of the remaining cash. Personally, however, I never take refinance into account for cash-on-cash calculations.
As for capital improvements, they are a part of the original equity and an indirect factor in CoC and IRR
Rental Property Investor · RVA · Member since 2016 · 5k+ posts · 4k+ votes
7y
I've not included it in my IRR or CoC calculations because I consider a refinance to be an icing-on-the-cake situation. If we're in a position to refi and return capital down the road, that's great. Investors keep their shares and get to go reinvest those funds elsewhere. However, I do not rely on that additional leverage to goose the pro forma return calculation. The deal should stand on its own without that.
To the extent a refinance decreases your total invested capital, it does make investments more qualitatively attractive. Everyone loves a cash-flowing asset that they have no money in yet earn a return on every month.
With regard to CoC ROI on properties which I invest in at a discounted value, I always use my total equity position in the property and my initial investment. Although I may not have invested the total equity position, it more accurately represents the amount of liquidity that could be freed up and used to generate a return elsewhere.
IRR: I would agree with @Nick B. IRR captures cash flows over time and refinance cash is one of them. I understand the "icing on the cake" approach (and this is how it feels) but it might be worth capturing that flow of cash somewhere in financial analysis.
Cash on Cash: Should this be specified as "Cash on Cash after refinancing"?
I was reading F. Gallinelli book on cash flow and could not find any mention of this.
Developer · Charlottesville, VA · Member since 2018 · 4k+ posts · 4k+ votes
7y
If all equity capital is returned on refinance your calculations are terminated. The returns are what they are at that point in time. You cannot carry returned equity forward into a financial model. Your return is infinite once capital has been returned.
Rental Property Investor · Southport, CT · Member since 2008 · 160 posts · 137 votes
7y
@Florent Breton I don't believe I had a specific example showing the affect of a refinance on IRR in my book, but Nick B.is correct. IRR is all about finding the unique discount rate that takes into account the timing and amount of ALL of the cash flows. The refi not only introduces into the income stream a particular cash flow at a particular time, but it necessarily affects post-refi cash flow amounts by changing what would have been the debt service and proceeds of sale if the IRR had not occurred. In short, the re-fi alters the timing and amount of cash flows, and therefore alters the IRR.
Specialist · Fairfield, CT · Member since 2019 · 36 posts · 51 votes
7y
Yes, refinancing affects the IRR; all cash flows do. Simply put, what money is invested and when? Then what money is returned and when?
As far as cash-on-cash goes, once investor capital has been returned there can be no cash-on-cash return--there is no cash left in the deal. This is why hurdles are calculated using IRRs or Equity Multiples. You can still check the math on what your cash-on-cash return is per quarter--it's nice to present to investors and for valuation purposes--but from a waterfall perspective it's not relevant.
Rental Property Investor · WA · Member since 2015 · 104 posts · 31 votes
7y
@Florent Breton I would agree with most people and say that you should include the refinance in your calculation. I am a very conservative person as it sounds you are, and I like to give people the worst case scenario if we are going to be partners on a deal. But, one thing I have learned, although you want to underwrite and display conservative numbers, they have to be accurate numbers based upon your forecasting. Otherwise no investment make sense. Not including the refi, would be an unrealistic (if you plan to refi) forecast, thus skewing all your numbers.
This will become a factor when you are looking to raise money for a deal and you plan for a refinance but don’t show numbers for refinance. I’d also say you may be potentially losing out on deals if you never plan to refinance because you are not able to put your capital to work as effectively as if you refinanced and moved to another deal.
Just my thoughts. Let me know if I can help in any way.
Thank you everyone!! This is super helpful and I hope it will also enlighten other members in the BP community!
@Frank Gallinelli I'm so honored to have you replying back to this thread. I've used your book "What every real estate investor needs to know about cash flow" as my Real Estate Bible and promoted it to friends! As a Columbia GSB Alumni, I also feel proud to have a faculty member jumping into forums to help around.
PS: I will also make sure to turn on notification when a reply is posted since I didn't see the replies before being mentioned.
Rental Property Investor · Southport, CT · Member since 2008 · 160 posts · 137 votes
7y
@Florent Breton The honor is mine, knowing someone actually reads my books and finds them helpful. Thanks. Feel free to ask me a question any time (preferably one I can answer).