Glendale, CA · Member since 2018 · 60 posts · 13 votes
Let's say we acquired property on a year 0 for 100k. Let's say we had a cashflow of 10k every year, for years 1 to 5 and on the year 5 we also sold the property for 130k. The question is why when we calculate the IRR, we do it as if all those cashflows were reinvested into the property? Because in reality when we get 10k in the end of year 1, we are free to do with it whatever we want and oftentimes we won't reinvest it in the property, right? So does it only make sense if we reinvest or I miss something?
Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
7y
@Vlad Denisov it is actually much more simple. IRR is considering all cash flow events, both positive and negative. You can spend the money on girls and boose or reinvest, doesn't matter.
The important consideration for you is what negative cash flow events do you have over 10 years? Do you need a new roof? Windows? Sewer lateral? New kitchens? Do you remodel before you sell? Once you understand this, you start to see why it is so much more important to understand the condition of the property.
New investors spend a great deal of time and energy to worry about rents and if they are $50 more or less, but turn a completley black eye to the roof, that has only 5 years left and will take $10,000 to replace (not to mention all the other items).
Generally sellers don't discount their dated properties enough to reflect the condition of major components. They will typically ask almost the same as the listing that had $50k worth of updates.
Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
7y
@Vlad Denisov it is actually much more simple. IRR is considering all cash flow events, both positive and negative. You can spend the money on girls and boose or reinvest, doesn't matter.
The important consideration for you is what negative cash flow events do you have over 10 years? Do you need a new roof? Windows? Sewer lateral? New kitchens? Do you remodel before you sell? Once you understand this, you start to see why it is so much more important to understand the condition of the property.
New investors spend a great deal of time and energy to worry about rents and if they are $50 more or less, but turn a completley black eye to the roof, that has only 5 years left and will take $10,000 to replace (not to mention all the other items).
Generally sellers don't discount their dated properties enough to reflect the condition of major components. They will typically ask almost the same as the listing that had $50k worth of updates.
@Vlad Denisov it is actually much more simple. IRR is considering all cash flow events, both positive and negative. You can spend the money on girls and boose or reinvest, doesn't matter.
The important consideration for you is what negative cash flow events do you have over 10 years? Do you need a new roof? Windows? Sewer lateral? New kitchens? Do you remodel before you sell? Once you understand this, you start to see why it is so much more important to understand the condition of the property.
New investors spend a great deal of time and energy to worry about rents and if they are $50 more or less, but turn a completley black eye to the roof, that has only 5 years left and will take $10,000 to replace (not to mention all the other items).
Generally sellers don't discount their dated properties enough to reflect the condition of major components. They will typically ask almost the same as the listing that had $50k worth of updates.
Hi Marcus,
So, if we don't reinvest we are still getting the same IRR, right?
I got the point on CapEx that is not usually taken into account, thanks for insight.
@Vlad Denisov it is actually much more simple. IRR is considering all cash flow events, both positive and negative. You can spend the money on girls and boose or reinvest, doesn't matter.
The important consideration for you is what negative cash flow events do you have over 10 years? Do you need a new roof? Windows? Sewer lateral? New kitchens? Do you remodel before you sell? Once you understand this, you start to see why it is so much more important to understand the condition of the property.
New investors spend a great deal of time and energy to worry about rents and if they are $50 more or less, but turn a completley black eye to the roof, that has only 5 years left and will take $10,000 to replace (not to mention all the other items).
Generally sellers don't discount their dated properties enough to reflect the condition of major components. They will typically ask almost the same as the listing that had $50k worth of updates.
Hi Marcus,
So, if we don't reinvest we are still getting the same IRR, right?
I got the point on CapEx that is not usually taken into account, thanks for insight.
Correct. If you would reinvest it would be a seperate investment with it's own IRR.
Profit is profit, no matter if you save it, gamble it away in Vegas or put in a CD.
Rental Property Investor · Nolanville, TX · Member since 2008 · 130 posts · 88 votes
7y
I look at IRR for buy and holds, but my real driving factor is cash flow. IRR is more like if I put the money in a stock, what's my return vs if I put it in a property, what's my return? I can do whatever I want with either pot of cash in the end.
Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
7y
IRR assumes the interim cash flows are reinvested at the projects total IRR. The interim cash flows can be reinvested in the subject property or in a totally different investment.
MIRR allows you to modify the reinvestment rate. For example, many companies will use their cost of capital/debt as the reinvestment rate for an MIRR calculation. If interim cash flows are not reinvested or used to pay down debt, it drives down the MIRR of the project.
IRR assumes the interim cash flows are reinvested at the projects total IRR. The interim cash flows can be reinvested in the subject property or in a totally different investment.
MIRR allows you to modify the reinvestment rate. For example, many companies will use their cost of capital/debt as the reinvestment rate for an MIRR calculation. If interim cash flows are not reinvested or used to pay down debt, it drives down the MIRR of the project.
Hi Mike,
I'm confused, because people above are saying that it doesn't matter and we don't have to reinvest it. What is it I'm not getting?
IRR does not assume a reinvestment rate. That is very well known misconception inside the corporate finance world.
IRR is simply a formula used to measure the efficiency of a particular investment relative to another. It only gives you a snap shot of POTENTIAL returns, not actual.
IRR must be taken into consideration along with the NPV of an investment. You can have 2 different projects and one shows a higher IRR than the other but the project with the lower IRR may have a higher NPV whcih would make it a better investment.
Before I go into a tangent and write a book it must be understood that real estate finance isn't something that can be learned piece meal. It's a complex and multifaceted art/science that has to be considered as a whole that took me almost 2 years to learn it from Harvard ( not a snobbish name drop, just a fact.)
Investor · Flower Mound, TX · Member since 2016 · 17 posts · 17 votes
7y
@Chase McArthur
Agree 100%. Would add that if you solve IRR in a DCF model where NPV =$0 you can compare that rate against all potential investments to help determine which will be best. Higher the rate higher the potential return
Let's say we acquired property on a year 0 for 100k. Let's say we had a cashflow of 10k every year, for years 1 to 5 and on the year 5 we also sold the property for 130k. The question is why when we calculate the IRR, we do it as if all those cashflows were reinvested into the property? Because in reality when we get 10k in the end of year 1, we are free to do with it whatever we want and oftentimes we won't reinvest it in the property, right? So does it only make sense if we reinvest or I miss something?
Vlad, interesting to see how this thread evolved. Good news is you don't need to go to Harvard to buy a duplex. The fact that you are looking into IRR sets you apart from 80% of the crowd who is looking at cash flow as their only metric.