Comparing IRR, Equity Multiple and Cash Returns in Real Estate Investments
Investors seeking a haven from volatile money markets and opportunities to diversify portfolios should consider the benefits of investing in private real estate. When weighing the potential return of a private real estate investment, there are several terms, or metrics, investors can use to help quantify the potential for profit.
Below, we will take a look at three commonly used private real estate investment metrics and discuss how to apply them to assessing your investment strategy. However, as with any investment, it is important to conduct extensive research and make decisions in line with your specific short- and long-term financial goals.
What Is an Internal Rate of Return?
Internal Rate of Return (IRR) is a metric which helps investors determine the potential for profit in private real estate investments. Ultimately, it helps define the length of time an investor’s money is obligated to a particular investment project. The lengthier the investment period, the lower the IRR. This principle is an essential consideration for investors who place emphasis on the “time value of money” and prefer not to leave funds allocated to longer-term investments at the expense of missing out on short-term opportunities for growth.
Examining the Equity Multiple Principle
Like the concept of IRR, the Equity Multiple (EM) principle is another critical financial factor which helps investors assess the likelihood for profitability in private real estate investment opportunities. EM examines the total return an investor may expect at the end of the conclusion of an investment. It looks at the overall potential for profit compared to the equity invested. Unlike an IRR though, EM does not factor in the length of time a potential investor’s money would be obligated to a particular investment opportunity.
Assessing Cash Return Metrics
Last, but not least, cash return, sometimes called the “cash yield,” of a real estate investment compares the dollar amount invested to the annual profit, or income, generated. For many investors, the cash return concept offers a fast and easy way to visualize profit distribution throughout a real estate investment.
However, since cash return looks at the average income throughout an investment project, annual cash flow projections can vary considerably. For this reason, investors relying on cash return assessments should possess a clear and accurate understanding of the sponsor’s business plan and strategy.
Which Should You Use When Assessing an Investment’s Potential for Growth?
Combined IRR, EM and cash return helps estimate the potential for profit in new private real estate investment opportunities. However, individually, they offer investors an avenue to examine particular factors which are important with unique investment strategies. For example:
- IRR is a metric that tells an investor how profitable an investment may be, but doesn’t take into consideration the amount of total dollars delivered. A short-term investment may have a high IRR but deliver very few actual dollars relative to the invested amount.
- EM is a metric that accounts for capital appreciation. It tells an investor how many dollars they earned compared to their original investment. But since it doesn’t take into account time; the metric wouldn’t be able to differentiate the success of an investment that delivered a 2x EM over 3 years or ten years.
- Cash return is an optimal metric for investors to consider the dollar amount of distributions throughout the full duration of an investment.
Ultimately, accurately assessing the potential for gains requires an examination of all of the return metrics outlined above and making a decision which falls in line with your specific financial goals.
Connect with RCP to Learn More About Real Estate Investment Metrics
Are you interested in learning more about private real estate investment strategies? Then reach out to our knowledgeable team at Realty Capital Partners (RCP) today. Connect with RCP by calling (469) 533-4000 or send us an email at RCP@rcpinvestments.com.