Internal Rate of Return

[Jacob Plocinski]

I am currently reading What Every Real Estate Investor Needs to Know About Cash Flow by Frank Gallinelli. I just finished Chapter 5: Measuring the Return on a Real Estate Investment and yes my brain hurts, but in a great way!

He finished the chapter talking about IRR, MIRR, FMRR and CpA. I'm curious of real world examples of using the IRR, MIRR, and FMRR. How do you use these methods to change the way you invest in your properties?

I want to primarily focus on buy and hold, but after reading this chapter I definitely get the impression that the buy and hold model is great, but obviously has its limitations. If you are a buy and hold investor, do you use these calculations? How so, etc.?

I will most likely re-read this chapter again and try to digest a little bit more. I may be completely interpreting it incorrectly, but all advice, recommendations are great! Thanks.

[Paul Hormann]

Hi @Jacob Plocinski IRR is the big one that most investors will use. It differs from cash on cash return by looking at your total return over time, not just what you can expect in one year (yes, it's a bit confusing because IRR does provide an annual return number). I like to think of it like this: CoC return is like having a salary. IRR is like having a salary and contributing to a savings account. After say 5 years, the overall amount of money you made in each scenario will be different, because IRR takes into account all the ways you made money.

I like to use IRR to see what kind of upside I can look forward to over time. If I'm looking at a stagnant market and a short hold period, my IRR may not be much higher than my CoC, or possibly even lower if values rise slower than inflation. But, if I'm considering an emerging market and can project that values/rents will likely go up quite a bit, my IRR can become much higher than my initial CoC.

If your plan is to buy and hold basically forever, you can still benefit from doing an IRR calculation to see how the deal stacks up. I would project your hold period out over 10 years and see what your overall return would be if you were to sell it then. Compare that to other deals in other areas and you can get some valuable info. Hope this helps!