Understanding Underwriting Acronyms - For Newbies and Nerds

(EM, IRR, CoC, and Annualized Return)

When I began underwriting, and even many times today, I had to ask my mentor(s) what each of the metrics meant on our underwriting tool. Why were they so excited about cash on cash (CoC) for one deal, but more focused on the equity multiple (EM) on another? Why would they discuss annualized return more often for some equity groups and CoC or EM for others?

I still ask a lot of questions about this today even after underwriting $300M+ worth of multifamily (this may seem like a lot to some people, and a tiny amount to others, just the way multifamily investing works). A few things I have found about these deal metrics (and even some other metrics I won't go into on this post, trended and untrended yield on cost (just got taught this one recently)) is the following:

They tell slightly different performance and health metrics about a deal
They matter more to some sponsors, LPs, and private equity groups than others based on their risk tolerance, desire to redeploy their capital, and expectations for their equity (whether it is from them or the decision makers behind the scenes).
They compliment one another. Much like doing your blood work when you go to the doctor. You wouldn’t check your cholesterol only and call it a day. You normally pull a comprehensive blood panel to ensure you’re functioning well from head to toe.

For each metric mentioned above I am going to break down what it tells me about a deal, how it is objectively calculated, a quick example, and what people are looking for when this is their key metric. While you read this, if you think of questions that go unanswered please throw them in the comments and I will do my best to answer them or write about them in future posts.

1️⃣ Cash on Cash (CoC):

Cash on cash is calculated as annual cash flow: Cash on Cash (%) = (Annual Net Cash Flow / Total Invested Equity) * 100

Example: You invest $1M in a multifamily deal (for the ease of calculation we are going to assume you are the sole investor, and discuss NET cash flow as a 1 time number even though distributions are often paid monthly). Over the first year the NET cash flow is $80k (meaning this amount is freed up to be distributed to investors/yourself, or reinvested into the deal).

CoC = ($80k / $1M) * 100 = 8% CoC

It can be calculated annually, or as an average of all of the annual cash flows percentages across the duration of the deal. If you wanted the average CoC for a 5 year hold, you would calculate the annual cash flow % for each individual year, sum them up, and then divide by the number of years you held the deal.

CoC is a good representation of the blood flow of your deal. How self-sustaining is it? How much NET income is this business (yes each multifamily property is a business) throwing off to keep itself alive each year)?

This is great for individuals or groups looking for lower risk deals that can breathe from the beginning. It usually infers you are walking into a more stable asset, or at least achieving stability earlier in a deal’s lifetime. Vacancy, repairs and maintenance, and capex are usually in check because NET income captures everything. Any pressure on income or expenses flows straight to the bottom and quickly wipes out free cash flow. You can still have a few bad months as long as the average across the year produces the NET cash you want.

You would think that CoC would be the king of deal metrics because of what it represents: blood flow year over year and self sustainability, but that is not always the case.

There are times where great CoC numbers are low or nonexistent, but your overall returns are still great.

This usually happens in high appreciation areas / assets (low cap rates), new(er) construction, or value add projects. These areas and assets mean you are usually playing a game of appreciation / depreciation. You are buying a highly valuable and stable asset in a great location at a high basis (paying market value or above) in order to claim depreciation on your purchase, put your money in a safe place, and expect the asset to appreciate at least the same if not more than it has over the previous years. OR you are buying a property with a plan for a major upgrade (value add) where you will be pouring capital into it for a period of time, limiting your ability to give distributions until the business plan has been realized. But when it has been realized you reap the rewards of executing on the plan, reinventing the asset, and “forcing” appreciation.

Lower cap rates are generally what you will see in B+ or better assets in strong areas. The market is too competitive to buy at a basis (purchase price) that keeps debt service (principal and interest), taxes, and insurance low enough to produce the same level of cash flow as deals in other areas. If you do find an exceptional asset in a great area that throws off strong cash flow, one of two things is likely true: you found a great deal, or your assumptions are off.

This is also why many investors pursue development or value-add strategies (amidst many other reasons). It allows them to create an exceptional asset in a great area from something that either didn’t exist or was underperforming at acquisition.

For groups that don’t want to develop or take on heavy value add, they end up paying a higher basis, carrying higher debt service and taxes, and accepting lower CoC to win on appreciation over time in lower-risk assets and areas. This typically still drives high EMs and annualized returns, but results in smaller cash flow distributions throughout the hold period.

In summary, lower cash on cash return usually works best for:

Individuals who value depreciation and tax advantages more than near-term cash flow
Investors targeting lower-risk areas and more stable assets (location, asset quality, long-term hold)
Those willing to wait 3, 5, 7, or 10 years for a larger payout, with refis potentially returning some capital along the way
Sponsors focused on value-add or development, where heavier CapEx, rehab, or lease-up is required before consistent cash flow
Groups aiming to stabilize, then refinance into better debt to reduce debt service and increase distributions, or exit at a higher valuation once the business plan is executed

2️⃣ Equity multiple (EM):

Equity multiple is the 10,000 foot view of the deal’s performance. It doesn’t tell you about distributions, annual returns, or if capital got returned earlier or later in the deal. It displays what your total return was for the deal compared to your initial investment. It can show this for a deal overall OR for different classes of shares (since waterfalls and post hurdle splits differ from deal to deal, sponsor to sponsor, and class to class).

For simplicity’s sake, though, it tells an investor what they walk away with at the end of a deal relative to their initial investment.

Equity Multiple = (Total Cash Distributions + Net Sale Proceeds) ÷ Initial Equity Investment

Example: If you invest $100k and the projected equity multiple is 2.0, you’re expecting to away with 2.0x your initial equity, or $200k total. That’s $100k in profit after getting your original capital back and accounting for taxes on the gains.

Initial Equity Investment = $100,000

Total Cash Distributions = $50,000

Net Sale Proceeds = $150,000

Equity Multiple = ($50,000 + $150,000) ÷ $100,000

Equity Multiple = $200,000 ÷ $100,000

Equity Multiple = 2x

Investors use this to quickly understand what they’ll walk away with at exit, how long it takes to 1.5x or 2x their money, and whether the hold period is actually worth it.

You may see a 1.5 equity multiple and think it looks great, but you need to look at how long it takes to get there, and how much risk is involved. Is this new construction, heavy value add, or a stabilized A class asset in a strong area?

There are a lot of variables to weigh before deciding if that equity multiple actually aligns with your goals.

Continuing with the 1.5 equity multiple example, you want to understand:

- Is this a 2 year hold (25% annualized return on average)?

- Is this a 5 year hold (10% annualized return on average)?

- What is the confidence interval of actually hitting that equity multiple? How likely does the sponsor think it is, and if they miss, how far off could it be? 3 percent, 5 percent, 20 percent?

- What is the sponsor’s reputation? Are they new or do they consistently hit their projections

- Is this deal within their normal background? For example, is an A class operator taking on their first heavy value add, or the opposite

To wrap this section up:

- A 2.0 equity multiple may look great, but if it takes 10 years to hit, that is only a 10% annualized return

- A 1.5 equity multiple may sound worse, but if it is over a 3 year hold with a reliable sponsor, that is closer to a 17% annualized return

- Shorter holds with strong annual returns can be more attractive if you can redeploy capital sooner

At the end of the day, this comes down to investor preference and capital strategy

Next lets discuss how we can analyze how the deal performed on average annually

3️⃣ Average Annualized return:

Annualized return goes hand in hand with the Equity Multiple by adding another layer of granularity to your projected returns. It tells you, on average, what your initial capital is earning each year over the life of the deal.
Example:
The nice part about annualized return is that it doesn't force you to look at a lump sum of EM. You can see on average what you are getting back year over year. This is a VERY important number for most investors and private equity groups. They are very savvy and look at a full suite of metrics before deploying capital, but if the annualized return does not make sense up front, your tear sheet will look weak and raise concerns quickly.

Downsides to annualized:

No time value of money (IRR). Annualized treats all returns the same and does not weigh when the cash is received. It does not distinguish between capital returned early or late which matters if you want to recapture and redeploy capital while still collecting passive gains
You still need to understand the sponsor, risk assumptions, and confidence in hitting the projections. A strong EM and annualized return is only as credible as the group underwriting it
A high annualized return in a short hold may force you to redeploy capital quickly (some groups want this and others do not want to have to reassess another opportunity this quickly), and it does not account for LTCG vs STCG tax. Only a consideration if holding less than 2 years, but still important to mention that all of these metrics are but one color/shape in an overall bigger picture.

4️⃣ Internal Rate of Return (IRR):

Internal rate of return is an algebraic formula that accounts for the time value of money. It is more complex than other metrics and almost never solved manually, so it is typically built into whatever underwriting tool you are using, whether that is Excel, Google Sheets, or a proprietary model. In Excel, for example, you would use =XIRR(cash_flows, dates) or =IRR(cash_flows).

This can be best demonstrated using a deal comparison, and some of our metrics discussed above.

Deal A — With Distributions

Invest: $1,000,000

Y1: $100K

Y2: $100K

Y3: $100K + $1.5M exit

Deal B — No Distributions

Invest: $1,000,000

Y1: $0

Y2: $0

Y3: $1.8M exit

How the metrics read

Equity Multiple (EM)

Deal A: 1.8x

Deal B: 1.8x

Cash-on-Cash

Deal A: 10% annually

Deal B: 0%

Annualized Return

Deal A: ~26.7%

Deal B: ~26.7%

IRR

Deal A: ~23.3%

Deal B: ~21.6%

IRR analysis

Deal A: Earlier cash returned → ~23.3%

Deal B: All cash delayed → ~21.6%

Just because IRR requires a more complex formula does not mean it is inherently superior to the other metrics. For a quick read on a deal, the time value of money can be more nuanced than you actually need. Cash on cash, annualized return, and equity multiple will already tell you a lot about how the deal performs.

That said, IRR does a strong job of combining and weighting multiple variables, which is why it is widely used by investors and equity groups to understand return expectations. But it is still just one data point within the broader analysis of underwriting a deal.

There are more metrics you can use when analyzing a deal, but these are four of the most common. You will see them when underwriting for investors, reviewing a tear sheet as an investor, talking to a sponsor, or just getting started in real estate and learning how to underwrite.

I love multifamily real estate and investing.

Let me know below what numbers you look at most when underwriting deals. Do you view any of these metrics differently, or is there one I left out that makes or breaks a deal for you?

P.s. drop any topics you want me to expand on as well

P.p.s. keep pushing on your operations and investing, and reach out if you need help with ops, deal flow, or underwriting

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