Understanding Internal Rate of Return (IRR)
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Investment opportunities are only as good as the amount of return they offer. That’s investment 101. But when you’re trying to determine how to calculate the amount you can expect from a real estate venture, such as building a multifamily property, it quite literally pays to know not only what you can expect but when you can expect it.
What Is the Internal Rate of Return?
The Internal Rate of Return (IRR) takes into account the time value of money in accordance with discounted cash flow analysis. Obviously, factors such as inflation can make your dollar today worth far more than it will be in a week, month, or 20 years. When we are talking about commercial real estate, the process is further complicated.
To put it simply, the internal rate of return is used to measure an investment’s performance based on the percentage rate earned on each dollar invested for each period it is invested, according to Property Metrics.
Why Is IRR Important?
IRR is crucial for investors to analyze various projects and to compare them with confidence. There are several advantages to using IRR in commercial real estate estimation. Perhaps most importantly, IRR utilizes the time value of money which shows the appropriate value of the investment by discounting the time it will take to accrue. Plus, IRR is easy to calculate and offers a simplistic way to compare projects, and it mitigates the risk of coming up with a divergent rate of return.
How Multifamily Real Estate Developers Benefit from Calculating the IRR
To calculate the IRR of any project, you are essentially taking into consideration the cash flows net of financing to come up with a valuable equity. Complicated? Not really. In fact, you can easily use your Excel software program to calculate the values you’re looking for by simply inputting your numbers. Doing so puts you in a better position to determine the right investment for your project, or the right project to invest in altogether.
To evaluate your multifamily real estate opportunities the right way, and to avoid getting too far in with a project you shouldn’t be involved with, calculate the IRR from the get-go.