Understanding Return Metrics

[Mark Jones]

Hi BP,

I'm trying to get a better understanding of return metrics. I don't want this to turn into a thread where people ask me what type investment I'm looking at and giving me the numbers. I want to get the mechanics behind calculating returns so I can learn to get the numbers myself. For example why should I target a X IRR as opposed to a Y IRR?

If someone can point me to some resources for this I would appreciate that as well. 

Thanks in advance!

[Shafi Noss]

Here is an intuitive way to think of IRR:

When investing, you initially lose some cash, then you get a series of payments, often with a big final payment when your principal is returned. 

Now imagine that instead of investing you put that money into a bank account that paid you x% compound interest. What would x have to be so that you could withdraw the same amount from the bank account each year as you would have gotten paid on the investment? That's the IRR.

Personally I think it's a low quality metric for real estate. IRR assumes that any payouts are reinvested at the IRR, which is not realistic. This especially messes things up if there is an early refinance, which is common on apartment syndications. MIRR is a better metric that solves that problem. 

My preferred metric is CAGR (Compound Annualized Gross Return), to measure returns, and cashflow, to measure how much of those returns are liquid. 

A great resource is Frank Gallinelli's book, What Every Investor Needs to Know about Cash Flow (And 36 Other Key Invesment Measures. I recommend it.