Total return is the actual rate of return of an investment or a pool of investments over a given evaluation period which includes income and appreciation.
As a simple example, if an investment produces a yield of 5.0% each year for 3 years, and then is sold at a gain of 20.0%, the investment would have produced a total return of 35.0% (5.0% times 3 years plus 20.0%).
Cap rate and cash on cash are income metrics. Total return is different because it includes the appreciation aspect of an investment property. The income part of total return is net income or profit. Total return can be calculated on an annual basis or after the property is sold. When calculating total return on an annual basis, it tracks the trend in performance.
Another common metric used in real estate investing is the internal rate of return (IRR). IRR looks at cash flows. It sums up all the cash flows in an investment and averages them out. These cash flows include rental income, principal reduction, cash flow at the sale of the property, and any money paid to investors (i.e., dividends). IRR is represented as a percentage.
Compared to total return, IRR looks back at the investment. This is because all cash flows (including the sale of the property) are needed to calculate IRR. That isn’t the case with total return since it can be calculated over any period.
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Hypothetical example(s) are for illustrative purposes only and are not intended to represent the past or future performance of any specific investment.
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