Return of Capital

Return of capital is a payment to an investor that gives back part of the original investment rather than paying income earned on it. It inflates cash on cash return when it is mistaken for cash flow: refinance proceeds, a security deposit, or a reserve drawn down are cash received but not return on the cash invested.

The confusion shows up in two places. A cash-out refinance hands you money and shrinks the cash left in the deal; the money is borrowed, not earned, and the property now carries a larger payment. Counting it as return would show a spectacular year and a worse property.

The other is a partial one. Principal paydown moves your money from a loan balance into equity. Cash on cash correctly excludes it from the numerator because it is not cash in hand; total return correctly includes it because it is wealth. Keep the two straight: cash on cash measures income on your capital, and anything that simply returns the capital belongs in a different column.

Return to capital usually means return of capital: cash handed back to you out of the money you originally put in, not income the property earned. The test is whether the payment lowers what you still have at risk in the deal. If it does, it is capital coming back.

Return on capital is the earning number: annual pre-tax cash flow divided by total cash invested, which is the cash on cash return. Refinance proceeds, a returned security deposit and a drawn-down reserve are all return to capital, and counting any of them as cash flow overstates the return.

Further reading: Return of Capital on Wikipedia.