# Return on Capital vs Return of Capital

Updated: Mar 21, 2021

How’s your first week of 2021? I hope it’s better than 2020 J

For me, I attended a lot of conferences, listened to a lot of podcasts and absorbed Information like a sponge: What are the experts talking about? What might be the opportunities in 2021? What we need to stay away? Hopefully next week I can give you a short summary.

Today I am going to talk about a common “pitfall” in real estate syndication. As a passive investor, do you know the difference between “return on capital” and “return of capital”? Let’s use a simple example to illustrate the difference.

Let’s say you invest $100,000 into a deal, and the syndicator claims the “cash on cash return” is 10%. So the first year you collect $10,000. Simple, right? Question is, what’s your investment balance after the $10,000 distribution at the end of year 1?

If $10,000 is considered to be “return **of** capital”, you are not getting any return for your investment in year 1, you are simply getting your money back. Your balance is now $90,000.

If $10,000 is considered to be “return **on** capital”, your investment is still $100,000.

You might think as long as I am getting $10,000 every year, why do I care whether it’s “return of capital” or “return on capital”? The big difference is in year 5 when the property is sold. Usually the distribution waterfall in year 5 is as follows: pay LP preferred return à return remaining capital to LP à what’s left is then split between LP and GP as agreed, say 70/30.

Let’s say in year 5, after the property is sold and all the expenses are paid, we are left with X dollar.

If $10,000/year distribution is considered “return **of **capital”, then in year 5, you will get $10,000 (this is the distribution for year 5) + $50,000 (as GP already returned $50,000 capital to you) + 70%*(X-$10,000-$50,000). After you get paid, the GP is paid 30%*(X-$10,000-$50,000).

If $10,000/year distribution is considered “return **on** capital”, then in year 5, you will get $10,000 + $100,000 (your original capital) + 70%*(X-$10,000-$100,000). After you get paid, the GP is paid 30%*(X-$10,000-$100,000).

Now open the PPM and if you find statement like “all the cash distribution is considered return **of **capital”, at the same time, you also see the syndicator calls 10% “cash **on** cash return” (remember, this is not return on your investment, s/he is simply returning your own money back!), s/he is either trying to mislead you, or at best s/he is incompetent to tell the differences. Run away from these syndicators, as fast as you can!

**Invest with Confidence.**

** **

** Yan Yan**

**Sharpe Investor Group**
www.sharpeinvestorgroup.com

**Want to invest for passive income?** **Click here**