These two numbers often appear side by side in a real estate pitch deck. They are not the same thing. And understanding the difference will protect you.
Cash-on-cash return is simple. If you invest $100,000 and receive $8,000 in distributions this year, your cash-on-cash return is 8%. It measures what you are actually receiving in your pocket right now. It does not care about what happens at sale.
IRR (internal rate of return) is more complex. It accounts for the timing and size of every cash flow, including the exit. A deal that generates modest cash flow but sells at a high price in year three can show a very high IRR.
Here is where it gets important:
IRR can be manipulated. A sponsor who models a quick exit (e.g. sell after 2-3 years versus our typical hold period of 4-6) at an aggressive price can make a mediocre deal look exceptional on paper. The IRR looks great. The underlying assumptions are not.
Cash-on-cash is harder to spin. Either you are receiving distributions or you are not. When I look at a deal, I want to see both. But if the cash-on-cash is weak and the IRR is high, I want to understand exactly what exit assumption is driving that IRR and whether I believe it (usually this is a result of a low exit cap rate, we'll talk about exit cap rate in the next few weeks).
Strong deals show strong returns on both measures. When they diverge, ask why.
Which metric do you weight more heavily when evaluating a deal?
Wednesday Real Estate 101: Cash-on-cash return vs. IRR
