What is the difference between Return of Capital vs. Return on Capital?
What is the difference between Return of Capital vs. Return on Capital?
One question that beginner investors often ask is, “what is the difference between ‘return of capital’ and ‘return on capital’?” Although these concepts seem very similar, they refer to two different financial concepts. Let’s discuss the differences so that you don’t mix up these two investing terms.
Investors often use the return on capital to measure how much money they make from their investment. Return on capital is when an investor gets a share of his original investment back. Return of capital is when an investor receives all or some of his initial investment back.
The difference between these two types of returns can be confusing, especially with many ways to calculate them. But understanding the differences will help you make better decisions about your investments and give you more insight into your financial progress over time.
Investors must know what type of return they are earning because it can affect other aspects, such as taxes and retirement planning strategies, down the line. The last thing you want is for this information to come as a surprise months before you are ready to retire.
Before you can determine the difference between the return of capital and return on capital, it’s crucial to understand how each one works.
What is Return on Capital?
The return on capital is the share of your original investment that you get back after a set period. Return on capital includes dividends, interest payments, or any other distributions from an investment.
What is Return of Capital?
On the other hand, the return of capital represents all or part of an investor’s original investment coming back into their pocket after a certain amount of time has elapsed.
You can measure the return of capital by determining an investor’s investment amount as a percentage of his overall net worth. Investors always calculate the return of money as a percentage against their original investment due to compound interest.
What’s the Difference Between the Two?
Return on capital is the amount of money an investor gets back as a share of his original investment and doesn’t include the total value.
However, the return of capital represents all or part of an investor’s original investment coming back into their pocket after a certain amount of time has elapsed. It is measured as a percentage against the overall net worth at a particular point in time.
Why Does Return on Capital Matter to Real Estate Investors?
Since real estate investors typically use the analogy of buying a house for their investments, return on capital is generally used to measure if their home equity has grown with time.
A higher return on capital will help them pay off more debt over time and potentially assist in paying off the mortgage.
Why Does Return of Capital Matter to Real Estate Syndicators?
Return of capital matters to real estate syndicators because it directly affects their cash flow. If a real estate investment returns the investor’s money, then the syndicator must pay out of pocket for any additional fees associated with that property.
For example, suppose an investor does not have enough capital to cover his initial 1% acquisition fee on a million-dollar property. In that case, he will have to come up with $10K to purchase the property. The return of capital means 1% interest is due, while the return on capital means no interest is due.
Another example would be if an investor purchases $100k worth of shares and expects to receive $101k back at some point after fees and other costs, they will not receive $101k. Instead, they’ll earn less than the total $101k amount. Still, they will accept whatever amount they originally spent fewer fees (i.e., the return of capital).
A third example would be if an investor buys $100k worth of shares and expects to receive $1k back in dividends after fees and other costs. Yet, after deductions from their initial sale amount, they will not receive $1k. Instead, they will earn whatever they originally spent minus fees, which reduce all distribution amounts paid out by the syndicator (i.e., the return of capital).
In Conclusion
There are two different types of returns. The return on capital is the share of your original investment that you get back after a set period. In contrast, the return of capital represents all or part of an investor’s initial investment coming back into their pocket after a certain amount of time has elapsed. Investors measure return on money as a percentage against their overall net worth at that particular point in time.
The difference between these two terms can be significant for real estate investors who want to know what type of return they are earning because it can affect other aspects, such as taxes and retirement planning strategies down the line. The last thing you want is for this information to come as surprise months before you are ready to retire!