Free and Clear Return

The total unlevered (before debt) pre-tax operating cash flow (i.e. Cash Flow from Operations) of a real estate project divided by the total capital invested, generally expressed as a percentage on an annual basis. To clarify, the numerator is typically total unlevered pre-tax operating cash flow (i.e. Cash Flow from Operations) in a given year, while the denominator contains the total amount of capital invested assuming there is no debt. While the Free and Clear Return does not account for taxes and does not take into account the time value of money, it is a useful screening tool used by investors when evaluating potential investments. The Free and Clear Return is the unlevered equivalent of the Cash-on-Cash Return, and thus sometimes referred to as the Unlevered Cash-on-Cash Return.

The Free and Clear Return of an investment is especially important to core investment strategy investors more interested in stable cash flow than in asset appreciation. The Free and Clear Return is typically used alongside other return metrics such as the Equity Multiple and Internal Rate of Return to appropriately assess an investment.

Putting ‘Free and Clear Return’ in Context

Sterling Creek Capital, a real estate investment firm specializing in core acquisitions, is evaluating the purchase of Willow Grove Shopping Center, a well-established 95,000 square foot grocery-anchored retail center located in suburban Atlanta, GA. The center is anchored by a national grocery chain and includes several smaller tenants, such as a coffee shop, a dry cleaner, and a fitness center. Due to the stability of the tenants and long-term lease agreements, this investment aligns with Sterling Creek’s core strategy, which prioritizes stable, low-risk cash flow over speculative property appreciation.

Sterling Creek is considering purchasing Willow Grove Shopping Center for $25 million. The projected total unlevered pre-tax cash flow from the property in the first year is expected to be $1.75 million, generated primarily through rent and reimbursements for property expenses such as Common Area Maintenance (CAM) charges. Since Sterling Creek plans to buy the property without financing (i.e., no debt), they are particularly interested in the Free and Clear Return to gauge the efficiency of the investment’s cash flow relative to the capital deployed.

Free and Clear Return Calculation

To calculate the Free and Clear Return, the firm divides the total unlevered pre-tax operating cash flow (i.e. Cash Flow from Operations) by the total capital invested:

Free and Clear Return = (Total Unlevered Pre-tax Operating Cash Flow / Total Capital Invested) × 100

In this case:

Free and Clear Return = (1,750,000 / 25,000,000) × 100 = 7.0%

Analysis

With a Free and Clear Return of 7.0%, this investment provides Sterling Creek Capital with a clear view of how much pre-tax cash flow is generated by the property in relation to the purchase price, without the influence of debt. This 7.0% return is considered solid for a core investment in a grocery-anchored retail center, especially in a suburban area like Atlanta where tenant demand is stable, and the grocery anchor provides a long-term, dependable source of income.

While the Free and Clear Return doesn’t factor in tax impacts or the time value of money (unlike more comprehensive metrics like the Internal Rate of Return), it gives Sterling Creek an important first-step look at the property’s ability to generate unleveraged cash flow. This type of return metric is particularly useful for a core investor, who prioritizes steady cash flow over riskier, value-add strategies that rely more on appreciation and leverage.

Sterling Creek can then compare this Free and Clear Return alongside other return metrics such as the Equity Multiple and the Internal Rate of Return (IRR) to assess the overall attractiveness of the investment.