Compound Interest

Compound interest is interest calculated on the principal plus all interest already added to it, so the balance grows faster each period. Cash on cash return does not compound. It measures one year of cash flow against the cash you put in, with no assumption about what happens to that cash afterward.

That is the main gap between cash on cash and multi-year measures. If you reinvest each year's $9,512 of cash flow at the same 6.3%, your money compounds. If it sits in a checking account, it does not. The one-year ratio is identical in both cases.

Compounding still shows up inside the deal. Mortgage interest compounds monthly, which is why the payment on a $375,000 loan at 7.25% is $2,558 and not a simple twelfth of the annual interest. Internal rate of return is the measure that captures compounding over the full hold.

Further reading: Compound Interest on Wikipedia.