Why I Only Pay As Much For Property As My IRR Allows Me

by | BiggerPockets.com

Throughout the lifespan of an investor, as we learn and mature, the methodology behind our analysis of investment opportunities changes. Have you noticed this yet?

Personally, even before I knew anything, I never placed much emphasis on cash on cash analysis. I did not know exactly what it was that bothered me, much less was I able to formulate it on paper, but I sensed that a lot was missing in the CCR analysis, that it was faulty in some way. There is definitely room for it in our understanding of facts, but not in the way most people think. The same can be said about CAP Rates – they are important in some way, but not the way most think.

I have no intention in focusing this article on these metrics, but I must tell you that the problem with them in the most broad strokes is the fact that both are static in their nature. This is to say that they populate static data upon which to calculate themselves, and in this way they are more or less a “snapshot” in time. Notice, CAP Rate is not a metric of return at all, but rather a metric that tracks the marketplace…

Related: The Definitive Guide to IRR (Internal Rate of Return)

Let Me Paint You a Picture

When you were in school, you received a grade card. This document looked back at your accomplishments in order to determine an average – the GPA. Then, in order to report to the State educational department, the school averaged the GPAs of all of the students in your class…

In this example, your GPA is akin to CCR – here’s the cash you invested, and here’s the cash you got out, and here’s the relationship of one to the other. And the average of all of the participants in the marketplace, which is the CAP Rate, is akin to averaging all of the GPAs of all of the students in your class. So, CCR is how well you’ve performed, and the CAP Rate is how well the market has performed.

Something to Note

Both of these metrics are forward-looking. They have to be, by definition, since it is only possible to average previous results. In order to try and extrapolate future performance from these numbers, we must discount them in anticipation of a whole lot of different things happening at some intervals with some percentage of likelihood.

Neither CCR nor CAP Rate do that, which is why, while I rely on both at certain junctures in the work flow of my underwriting, I do so for purposes other than projection of future ROI. And when I see people sell investment opportunities, either in the multifamily or turnkey SFR spaces, based on annualized CCR, I am not sure whether to laugh at the lack of sophistication of the operator, or cry at the stupidity of the investor in today’s marketplace. Though, considering the amateur hour that we are living through, nothing should be a surprise…

Why I Underwrite to IRR

I couldn’t sell an investment opportunity to any of my guys based on anything other than IRR. This is because they understand that in order to underwrite an IRR, I have to project and discount future cash flows, which means that I have to pencil with great specificity every single aspect of the movement of money in and out for the entire life of this investment.

And sophisticated investors, the only kind I care to work with, want me to do just that. Why? So that they can have a chance to trace my thinking and to issue a verdict. If they agree with the picture that my numbers paints, they put money in, and if not, there’s no deal.

Why I Will Pay Only What My Underwriting Allows Me

Think through this with me:

My underwriting says that I can afford to pay $4.1 million and project 15.4% IRR. My guys agree that this is attractive and are willing to fund the deal – they are willing to go if I can project at least 15% IRR.

Now, remember I wrote an article a while back in which I told you that CapEx is not a percentage, but rather a fixed cost? If you don’t, read here. Well, since I know what minimum IRR my investors want in order to fund the deal, I now have another fixed cost – the IRR to my investors. It’s not a fixed cost on paper since that would be illegal. But how many times do you think I could under-perform and still keep my career? So, unless people start being satisfied with lower returns than 15% IRR, I indeed view this as my fixed cost.

Related: Why I Don’t Buy Houses for $30,000 or Apartments in D-Class Areas

So, I know how much of the profit goes to my LPs, which means that the rest goes to me. If I pay more than my underwriting says I should, this difference must come out of MY pocket. I can’t take from the LPs’ pocket because they won’t trust my projections the next time around. I have to choose to work for less.

Folks, Listen Up!

I don’t care what Brandon says on his webinars, or what anybody else says — there’s not a single glamorous thing about this business! There are certainly honest people in this business, but to get to them we have to go through hundreds of liars and cheats! And it doesn’t matter if we are talking tenants, contractors, city officials, you name it…

This is the hardest work any of you will ever do, period. You better have a reason for doing this that’s more significant than money or fame.

Knowing this, I don’t think I want to work for less! I am going to get paid, and paid well, with anything and everything I do, or I don’t play.

And this is why I can only pay for assets what I can pay. When starting out, I had to kiss frogs. Now, I don’t have to.

Investors: Which metrics weigh most heavily in your decision to buy investment property? Do you agree with my assessment?

Leave your comments and opinions below!

About Author

Ben Leybovich

Ben has been investing in multifamily residential real estate for over a decade. An expert in creative financing, he has been a guest on numerous real estate-related podcasts, including the BiggerPockets Podcast. He was also featured on the cover of REI Wealth Monthly and is a public speaker at events across the country. Most recently, he invested $20 million along with a partner into 215 units spread over two apartment communities in Phoenix. Ben is the creator of Cash Flow Freedom University and the author of House Hacking. Learn more about him at JustAskBenWhy.com.


  1. Don Nelson

    Thank you Ben. I’m still coming up to speed on many things, not the least of which is your comment about Capex being fixed cost, not a percentage. Are you saying that you review the capex history on the asset and take an average? And if you don’t project a percentage for Capex, don’t you put yourself at risk?

    • Ben Leybovich

      Yep – we know how much stuff costs, and we can project average time to replacement. This gives us a dollar amount – fixed cost that has nothing to do with income, and therefore can’t be tracked as a percentage effectively 🙂

  2. Al Williamson

    Amen, IRR fixed. Got it.

    But we disagree on one point – the business is enjoyable in my neck of the woods.

    I don’t see real estate investing and happiness/enjoyment as mutually exclusive.

    However, I greatly appreciate your attempt to more portray the business with more procession – it is not a big jelly bean.

    Thank you for the article.

  3. Ian Fisher

    Ben – you know I have a lot of respect for a lot of your commentary and knowledge. And I couldn’t agree more that COC / CAP rate only tell part of the story. But with all due respect, you’re falling into your own trap when you regard 15% IRR as an immutable Truth. How is this any different from people who talk about a 2% “rule”, a 50% “rule”, etc.? An IRR threshold for investors is just the same – it depends on a great many factors, including but not limited to how much risk is in the deal, what the investors’ overall objectives and other investments are, what their alternative uses of capital are / alternative investment opportunities on the table (i.e. their opportunity cost for the capital), how long the lock-up is, etc. I’m not suggesting for a moment that 15% or so can’t often be where things come out – but it’s just that, a shortcut, and doesn’t by any stretch of the imagination factor in everything that goes into (or should go into) an investor’s (and prior to that, a sponsor’s) evaluation of a deal. And I don’t disagree that it makes sense to have high standards for IRR – but I don’t think you have the full picture until you take the IRR you’ve modeled for your expected case, look at some upside / downside scenarios, and look at how it fits into the bigger picture for you and your investors.

    • Ben Leybovich

      Well, Ian – I know my investors, and I know myself. They need a certain return to be happy, and I need a certain return to want to work! I don’t particularly enjoy working hard, and would rather not do it at all than do it for pennies 🙂

      • Ian Fisher

        Would never suggest anyone work for pennies! My point is purely that 15% is an arbitrary number – some investors would not do a deal unless it projected higher, others might settle for less. Depends on all kinds of factors – risk profile, alternative options the investors have available, how long the lockup is, among dozens of others.

        Do we agree?

  4. IRR is good but there are a few problems. For one, it’s a relative measure which is why NPV is the better, especially when evaluating mutually exclusive projects. Because of the timing of cf and chosen discount rate, one might have a higher IRR but lower NPV and basing a decision solely on that could lead to missing out on some value.

    Ben, are you looking at the non discounted measures first to see what projects to look at further?

    • Ben Leybovich

      Yes, Josh – if investors want to discount my IRR and arrive at their MIRR discounted by whatever is appropriate rate for them, I say good for them. But, in order to compare apples to apples, I don’t do MIRR discount on my projections…

      You are right, however – discounting the IRR to NPV will get you the bulls eye future value, though it does require taking a guess on inflation 🙂

  5. Anthony Hornbeck

    Hey Ben, loved the article.

    Are you willing to share an example of your IRR projections?

    I’d like to better understand the numbers and timeframe you use.

    As Ian Fisher also posted, how big does the capital lock-up play into your IRR rate thresholds?


    • Ben Leybovich

      Not a chance on sharing 🙂

      Capital stays in for at least 5 years, and often 10 in this environment. However, the appetite is more driven by the quality of the marketplace and asset, rather than time-frame. In a land-locked high growth market people may accept less IRR due to the perceived safety…


  6. Mike Schena

    You must have very sophisticated investors. I remember reading an article where a majority of CEO’s were making decisions based on IRR while not understanding the inherent problems of the metric. I personally see no need for it. I can do intuitively what IRR would tell me based on a lot of excel work and assumptions.

    I’m never in a position where I’m analyzing two inherently different investments either. For me, it’s usually just to buy this property or that property or buy nothing at all. What are you using as a discount rate? Also, if someone starts quoting IRR to me, I’m immediately suspicious of their assumptions.

  7. Aleksandar P.

    Good article Ben.
    I love IRR because it gives me a way to asses my opportunity cost when investing money in a certain project. I invest in individual companies in the stock market and if you know what you are doing you can predict your IRR (or Rate of Return) with some certainty, particularly with Blue Chip companies. If I don’t get at least 5% higher IRR on Real Estate investment, looking on the time frame between 5-10 years, why would I bother with it? Keep in mind how much more time and resources you put into RE investment compared to investing in paper asset.


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