What is Equity Dividend Rate?
The Equity Dividend Rate (EDR) on a real estate property investment irepresents the ratio between the before-tax cash flows (BTCF) and the initial equity contribution, expressed as a percentage.
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How to Calculate Equity Dividend Rate
The equity dividend rate is the annual cash yield received by an investor on a stabilized real estate property investment, after deducting financing costs.
The equity dividend rate (EDR) is the annual return on the equity invested in a real estate property, and is calculated by comparing the property’s before tax cash flow (BTCF) to the equity contribution.
The equity dividend rate – or more commonly referred to as the “cash on cash return” among industry practitioners – measures the yield earned on an equity investment on an annualized basis.
The process of calculating the equity dividend rate requires two inputs: the before-tax cash flow and the initial equity contribution.
- Before-Tax Cash Flow (BTCF) → The pre-tax income of the property investment at stabilization. The numerator, the before-tax cash flow metric, is a levered cash flow metric since the annual debt service, which includes principal amortization and interest, is accounted for.
- Initial Equity Contribution → The equity investment on the date of the original property acquisition (or “down payment” in cash). The annual cash yield is a return metric from the perspective of the equity investor. Hence, the denominator is the equity contribution from the real estate investor, not the property purchase price, inclusive of the mortgage, commercial loan, or other non-equity financing securities.
Since the cash flow metric is reduced by financing costs, like mortgage payments and interest, the implied return is on a levered basis, i.e. attributable to solely the equity investor.
Therefore, the equity dividend rate measures the annual cash yield on the equity component of the property investment, rather than the return to all stakeholders.
Why? The distribution of proceeds must strictly abide by the liquidation preference, in which the placement of a stakeholder in the capital stack determines the order of repayment (and returns).
On the topic of timing, the before-tax cash flow (BTCF) metric must be presented on a post-stabilization basis, i.e. when the rental property is operating near its expected occupancy rate with pricing in line with the market rate.
For instance, a real estate development project can require years (or often even more than a decade) before the property is fully developed and starts to generate rental income on behalf of the owner.
Equity Dividend Rate Formula
The formula to calculate the equity dividend rate (EDR) is the ratio between the before-tax cash flow and initial equity contribution, expressed as a percentage.
Where:
- Before-Tax Cash Flow (BTCF) = Net Operating Income (NOI) – Annual Debt Service
- Initial Equity Contribution = Property Purchase Cost – Debt Financing – Non-Equity Capital Sources
The equity dividend rate is ordinarily expressed as a percentage to make comparisons of the cash yield of different properties easier – thus, multiply the output by 100 to convert the figure into percentage form.
Note: While the before-tax cash flow (BTCF) is a pre-tax metric – as implied by the name – property taxes are deducted because those are considered the operating costs of a property. The tax excluded from the metric are in reference to the income taxes paid to the federal government (IRS).
