All Forum Posts by: Abdul Azeez

Folks - There seems to be several major misconceptions above especially the reinvestment myth for IRR. Check out the article at http://www.propertymetrics.com/blog/2014/06/09/wha...

To quote:

The internal rate of return measures the return on the outstanding “internal” investment amount remaining in an investment for each period it is invested. The outstanding internal investment, as demonstrated above, can increase or decrease over the holding period. It says nothing about what happens to capital taken out of the investment.

The Myth of The Reinvestment Rate Assumption

One of the most commonly cited limitations of the IRR is the so called "reinvestment rate assumption." In short, the reinvestment rate assumption says that the IRR assumes interim cash flows are reinvested at the IRR, which of course isn't always feasible. The idea that the IRR assumes interim cash flows are reinvested is a major misconception that's unfortunately still taught by many business school professors today. 

i know what you are saying about some deficiencies of IRR. But it is still a metric that factors in time value of money and provides an overall number for a set of cash flows. Your ROI metric may be a misleading in this example because I don't believe it fully accounts for the time value. In this case I am not comparing projects of two different durations or evaluation between two opportunities. I am just looking at overall return which seems to go down over time.

cheryl - IRR is the overall return of a stream of cash flows. So I am correct in using it as an evaluation metric here.

Alexander - that makes sense. Thank you.

While on the topic, is it OK the way I have done to factor expenses related to getting property ready for rent as initial investment instead of repairs as part of first year operating expense or as capital cost? My rationale is this is not operating expense because it did not arise from operating the unit as a new rental and it does not fit cap cost because getting it ready may require some level of clean up and tuning none of which can be depreciated. Of course if the getting to ready involves installing new appliances or roof etc. I could move them to cap cost but at this time without doing an inspection I would not know it until a bit later if I do get it.

stephen - you hit the nail over the head!!! From the morning I was worried if my calculations were incorrect. But what you say makes perfect sense. So in this case I would think buy, rent and sell in two years makes sense. 

Michael - In terms of percentages, I have used 2% for property appreciation and 3% for rental appreciation. So, property appreciation is lower than rent appreciation in percentage terms but property appreciation may be higher on a dollar basis.

James - thanks for your response. That's exactly my confusion as to why IRR is going down. As you see the mortgage payoff reduces over the years so this has been factored in. I do have a line on the above analysis which does show cash on cash going up. Where do you factor the initial cost to get property to a rentable ability. I have factored it as part of my initial investment and not as part of the first year operating expense or capital cost. The reason for this is that this is a one time activity and inclusion of this in net operating income would result in negative cash flow. I have made it a part of cash on cash by using it as a denominator number as part of initial investment. I still do not know why IRR is decreasing over time. Seems like I have done everything correctly. Would appreciate if someone could shed some light on this.

john - thanks. That's what I have done isn't it or are you saying I have missed something? If it's the former then is my conclusion right in that the average return on this property is going down the longer I hold it and is a primary candidate for buying, renting for two years and then selling it off?

also expenses - rent is simplistic. Where do you factor in cash needed to get the property to a rent ready state? If you take it in expenses you will likely result in negative cash flow. That's why I have factored it in initial investment and a denominator number in cash on cash return.

tax is included. Look under expenses.